Recovery and the Reluctant Consumer
By DAVID LEONHARDT
The New York Times
Monday December 10 03:11 PM EST
<<American consumers may still want to spend, but the earnings gains that fuel buying are slowing.
As the ritual of end-of-the-year forecasts begins, Wall Street's legions of economists are lining up to predict the recession's imminent end. With signs emerging that manufacturing orders and business investment are starting to perk up, all that is needed, the optimists say, is for consumer spending, which has held up better than in past downturns, to improve just a little. All will then be well.
But one group of people may have a different idea: American consumers themselves. Though many still want to spend, the earnings gains that fuel buying are slowing and the fat bonuses that upper- income households have come to depend on around the new year are going to be much leaner. With unemployment mounting rapidly and salary freezes increasing, plenty of people have reason to keep spending tight and their credit cards under control.
"I still think consumers are being very, very selective in their purchases," said Robert L. Nardelli, chief executive of Home Depot. "I don't see all of a sudden a switch in which the frugality is gone."
Indeed, holiday shopping so far has been even more disappointing than anticipated. And the one clear piece of good news in consumer purchases the stunningly high automobile sales of the last two months has a dark lining to it. Once car companies stop offering the profit-sapping zero-interest financing that has lured buyers into the showrooms, sales are likely to drop sharply.
Certainly, there are still significant factors at work that should help counter these forces and buoy the economy next year. Low energy prices are saving people millions of dollars every day, money they can spend on products and services that employ Americans. The Federal Reserve is expected to cut interest rates for the 11th time this year when it meets tomorrow. Auto production is scheduled to expand to rebuild depleted inventories and housing activity remains healthy.
With hopes rising that the recession, which began in March, could soon end, investors have sent stock prices and bond yields higher in recent weeks.
But the potential for weakness in consumer spending underscores the unusual nature of this recession and heightens the risks facing the economy in the next few months. Even after a recovery begins, chances are good that it will be slow in picking up momentum, many economists say.
"This is a period in which you are going to see a number of cross-currents," said Gail Fosler, chief economist at the Conference Board, a research group in New York. Even though she expects a recovery to begin soon, "I see it as much more of a slow-starting recovery," she said, in which joblessness continues to rise and most Americans consider the country to be in recession well after economists decide it officially ended. Fed officials have made similar comments in recent days.
A chief cause of the current recession has been the sharp decline in business spending, which has fallen as a result of the overcapacity caused by excessive investments in the booming late 90's. By contrast, household spending, while slower, has continued to rise this year.
This pattern is far different from the recessions that have occurred the last few decades. Such downturns almost always followed increases in interest rates imposed by the Federal Reserve to dampen inflation. That caused consumers to delay or cancel many purchases, setting off a wave of production cuts and assembly-line job layoffs.
Soon, however, Americans began buying again, and the pent-up demand for new houses, cars, kitchen appliances and other high-cost items helped the economy rebound.
This year, spending on such items has remained surprisingly strong, and there is probably less pent-up demand than at the end of previous downturns. As a result, consumer spending could be weak even as business investment recovers, some economists say.
"Simply put," said Robert J. Barbera, the chief economist at Hoenig & Company, "a boom in autos and housing is impossible from current levels."
Spending on less expensive items has already slowed, although the unusually warm weather last month could have temporarily depressed interest in things like sweaters, coats and scarves. Chain stores reported last week that their sales in November, adjusted to take account of differences in the calendar, were only 0.5 percent higher than in November 2000, according to the Bank of Tokyo- Mitsubishi.
That was an even smaller year- over-year increase than in September, when the terrorist attacks kept many shoppers at home.
"This is definitely a difficult economy, and that's not going to change in the near future," said Carol Sanger, a spokeswoman for Federated Department Stores.
That is coming from a company that was one of the few retailers with increased sales last month. At both J. Crew and The Gap chains, sales fell 25 percent compared with November 2000. At Men's Wearhouse, the decline was 15 percent.
The weak sales figures followed months of slowing salary increases. From the mid-1990's until early last year, pay increased at annual rates of 5 to 7 percent, according to the government's broadest measure of income received by working Americans. This summer, the rate fell to about 3 percent.
While rank-and-file workers are still benefiting from modest hourly wage gains, the overall measure which includes salaried employees dropped to zero between June and October, the most recent month for which the Commerce Department has published data.
And it is unlikely to pick up early next year, compensation experts say, because many companies are cutting back on salary increases for 2002 and on year-end bonuses, most of which will paid early next year. Because variable-pay plans are far more popular than they were a decade ago, when the United States was last in recession, the cutbacks could have an unusually big effect on the broad economy.
In 1990, only 47 percent of companies used at least one form of variable pay including bonuses, stock options, and stock grants according to a survey by Hewitt Associates, a human resources consulting firm. Last year, 78 percent did.
At many companies, workers are now experiencing the flip side of the raises and year-end checks of the booming late 90's. From 1996 to 2000, those pay increases helped consumer spending grow faster in the first three months of the following year, by an average of 0.8 percent, than it had in the previous two quarters, said Stephen S. Roach, chief economist at Morgan Stanley.
In early 2002, said Mr. Roach, one of Wall Street's relatively few pessimists, pay cuts will limit household spending. "In a few weeks, people will hear the bad news," he said.
Already, Credit Suisse First Boston said last week that it was postponing year-end raises indefinitely. Merrill Lynch has frozen salaries until the middle of next year. Ford is requiring many workers to pay more of their health care costs and is not giving any merit raises to 2,000 executives.
Skadden, Arps, Slate, Meagher & Flom, the nation's largest law firm, plans to pay year-end bonuses that are just a fraction of last year's. Another big New York firm, Davis Polk & Wardwell, told lawyers not to expect any bonus. Last year, many of the richest law firms paid large bonuses.
Over all, 55 percent of big companies have reduced the pool of money they set aside to pay bonuses, according to a survey by William M. Mercer, a consulting firm. Twenty percent already plan to hold down salary increases, 8 percent are lengthening the time between raises, and 2 percent are freezing salaries entirely, the firm said.
Steven E. Gross, the head of Mercer's employee-pay practice, said he expected that the reductions could become even greater once companies made the final, year-end comparison between their profits and their salary budgets.
"There's some wishful thinking going on," Mr. Gross said.
With so many people being asked to settle for little more than a nice pat on the back from their bosses this year, many executives are less optimistic than forecasters and investors are, and say that they will be happy to eke out modest gains until late next year.
"I certainly don't feel that this is going to be a V-shaped recovery," Mr. Nardelli of Home Depot remarked.>> |
