Global: Missing Pieces, by Stephen Roach (New York)
Nov 10, 2003
The missing pieces of economic recovery finally appear to have fallen into place. At long last, America has started hiring again, setting in motion a dynamic that lies at the heart of any cyclical upturn in economic activity. For those of us who have been stressing downside risks to the macro climate, this is the time to take some chips off the table. After the weakest start to an economic recovery on record, over the past seven months the US economy has certainly been stronger than I had thought. The obvious and important tactical question is whether this newfound vigor is sustainable. But the deeper strategic question is whether cyclical recovery refutes the macro of structural imbalances that has long been central to my relatively gloomy view of the world.
While stronger than expected, the latest US employment numbers are hardly in keeping with the vigorous hiring-led upturns of the past. In the recoveries of the mid-1970s and early 1980s, for example, the great American job machine was generating new employment of around 300,000 per month within six months after cyclical upturns commenced. In the cycle of the early 1990s — America’s first jobless recovery — it took a year for the job machine to finally shift into gear and nearly two years before monthly hiring breached the 200,000 threshold. In this broader context, job gains of 125,000 over the past two months remain woefully deficient. Normally, at this stage of a cyclical upturn — fully 23 months after the trough of a recession — private-sector hiring is up about 5.5% (based on the average of the six preceding business cycles). As of October 2003, the private job count was still down nearly 1% from the level prevailing at the official cyclical turning point in November 2001. By my reckoning, that still works out to a cyclical shortfall of close to 7 million jobs — the number of Americans who would have been at work in the private sector had the current hiring recovery conformed to the cyclical norms of the past. In short, while the US appears to have transitioned from a jobless to a job-short recovery, it’s a real stretch to argue that hiring has now reached the critical mass that sparks cumulative cyclical increases in the real economy.
The detail behind the hiring improvement of the past three months bears special attention. Yes, the rate of decline in manufacturing employment is diminishing, leading some to conclude that this carnage is nearing an end. That remains to be seen. The point is that factory payrolls were still contracting fully 23 months into an economic recovery. This development remains unprecedented in the modern-day experience of the US economy. Yes, there has been a secular downtrend in US manufacturing employment for the past half century, taking this segment of the workforce down to 13% of total private payrolls. But the standard business cycle upturn normally provides temporary respite from this secular erosion — having boosted manufacturing employment, on average, by over 5% in the first 23 months of the past six upturns. That’s not the case in the current cycle: An 8% decline since November 2001 leaves factory payrolls fully 2.1 million short of historical norms.
Which takes me to one of the key building blocks of my own macro framework — the global labor arbitrage. Notwithstanding the upside surprises in the October labor market surveys, I do not believe that three months of anemic hiring herald the restoration of the time-honored relationship between aggregate demand and employment. Job creation is still under acute pressure in those industries that remain most exposed to the twin forces of international competition and outsourcing — especially manufacturing, wholesale distribution, air transportation, telecommunications, information service providers, and finance and insurance. By contrast, the hiring growth that is now occurring appears to be skewed toward those segments of the US economy that are far more self-contained. Indeed, it turns out that fully 78% of the employment growth over the past three months has been concentrated in three of the most sheltered segments of the workforce — education and health services, temporary staffing, and government. That hardly qualifies as a full-fledged upturn in business hiring that lays the groundwork for a classic cyclical revival. The global labor arbitrage stresses the persistent leakage of domestic income generation to offshore production platforms — in goods and services, alike. In my view, there’s little reason or statistical evidence to believe that these pressures have suddenly vanished into thin air.
The art of cyclical analysis lies in being able to distinguish those elements of the current climate that differ from the dynamics of the past. While history is replete with rich lessons, I believe the most relevant comparisons are with the experience of a decade ago — America’s first jobless recovery. At that time, an unprecedented shortfall of job creation gave rise to a similar confluence of economic and political concerns. It even unseated a President by the name of George Bush. Yet despite all odds, that anemic recovery eventually gave way to a powerful upturn that ushered in a period of extraordinary prosperity in the United States. There are many who believe that just such a transition is at hand once again — albeit after an unusually long and painful delay. Incumbent politicians and a broad consensus of economists and investors are particularly enamored of this view. Their case is based largely on the interplay of several potentially powerful forces — earnings vigor, surging productivity, a pipeline of fiscal stimulus, and lean inventories. Moreover, compared with the previous jobless recovery, America’s banking system is in far better shape, ready to play a much more active role in intermediating credit into the real economy than the crisis-torn banking system did a decade ago.
I don’t minimize those positives. But, in my view, there are some equally critical differences between the state of today’s US economy and conditions prevailing in the upturn of the early 1990s — differences that challenge the notion that a comparable transition is about to begin. That’s especially true of consumer balance sheets: Today, household sector debt stands in excess of 80% of GDP, well above the 65% reading in 1992 when the last jobless recovery first started getting traction; moreover, despite extraordinarily low interest rates, household debt-service-to-income ratios currently stand at around 14%, far in excess of the 12% readings that facilitated expansion a decade ago. Moreover, today’s record 5.1% current account deficit is in sharp contrast with the virtual balance in America’s external accounts that was evident at the onset of the recovery of the early 1990s. At the same time, the private sector’s net saving rate — consumers and businesses, combined (net of depreciation) — stood at 8% a decade ago, double the anemic 4% rate of today; that underscores the diminished reservoir of funds that the private economy has at its disposal to finance economic recovery.
But that’s not all. In today’s US economy, there’s a veritable lack of pent-up demand in the two sectors that normally spark cyclical upturns; consumer durables currently stand at a record 11.4% of GDP versus a sub-7% reading in the early 1990s, and residential construction has moved up to a cycle high 4.3% of GDP versus a 3.3% reading a decade ago. Lacking in classic sources of pent-up demand, America is more than ever in need of new sources of growth. And, finally, there are the persistent imbalances of a lopsided global economy. With its China-like GDP growth of 7.2% in 3Q03, the US growth engine is once again accounting for the bulk of the improvement in the global economy. While the rest of the world seems to be more than delighted to finance this outcome with open-ended flows into US Treasuries, current-account, dollar and interest rate risks continue to build that could well jeopardize the macro climate in the not-so-distant future (see my November 7 dispatch, “Yet Another New Paradigm”).
All in all, the proverbial glass still looks half-empty to me. Obviously, financial markets and the forecasting community are now sensing a much higher fill line. I certainly concede that the October labor market data, in conjunction with upward revisions to August and September, draw my view into serious question. And I suspect there’s probably more to come on the upside of the data flow for a while. Yet I’ve been doing this long enough to know that validation or repudiation is a very slippery concept as marked to market by the ever-fickle US statistical system. For a saving-short, overly-indebted, post-bubble US economy, I continue to think it’s entirely premature to issue the all-clear sign. For growth-deficient foreign economies, a similar warning is in order: Lacking in domestic demand, there’s a limit to the potential vigor of a US-centric global growth dynamic. And for the world as a whole, globalization, and the global labor arbitrage it has fostered, remains a source of mounting tension in both economic and political arenas. In the end, I guess that’s the beauty — or the folly — of macro-analytics. You don’t blow with the wind when the numbers whip one way or another. My basic premise is that the stresses and strains of an unbalanced global economy remain very much intact — and not to be taken lightly. Call me stubborn, but I still see little reason to abandon the analytical framework that has done a pretty good job of capturing the flavor of a tough world over the past four years. |
