Global: False Recovery
morganstanley.com
Stephen Roach (New York)
Morgan Stanley
Jan 12, 2004
The Great American Job Machine has long powered the US business cycle. It drives the income growth that fuels personal consumption. That internally generated fuel is all but absent in the current upturn. The US economy is mired a jobless recovery the likes of which it has never seen. This has profound implications for the economic outlook, the political climate, trade policies, and the global business cycle.
Contrary to popular spin, the US labor market is not on the mend. In the final five months of 2003, a total of only 278,000 new jobs were added by nonfarm businesses — a gain that is easily matched in a single month of a typical hiring-led recovery. Moreover, literally all of the job growth that has occurred over this period has been concentrated in three industry segments — temporary staffing, education, and healthcare — which collectively added 286,000 positions in the final five months of last year. The “animal spirits” of a broad-based hiring-led revival by US businesses are all but absent. Jobs may be rising in America’s low-cost contingent workforce (temps) and in high-cost-areas that are shielded from international competition (health and education), but positions continue to be eliminated in manufacturing, retail trade, and financial and information services.
The modern-day US economy has never been through anything like this. Fully 25 months into this so-called economic recovery, private-sector jobs are still about 1% below levels prevailing at the official trough of the last recession in November 2001; at this juncture in the typical recovery, jobs are normally up about 6%. Had Corporate America held to the hiring trajectory of the typical cycle, fully 7.7 million more American workers would be employed today. Moreover, the current hiring shortfall far outstrips that which was evident in America’s only other jobless recovery — the upturn following the recession of 1990–91. In that instance, it took about 12 months for the job machine to kick back into gear. By our calculations, the current job profile in the private economy is now 2.4 million workers below the trajectory of the jobless recovery a decade ago.
Forward-looking financial markets have long presumed that America’s backward-looking malaise is about to change — that hiring is just around the corner. The optimists have continually drawn encouragement from declining levels of jobless unemployment insurance claims, improved purchasing managers’ sentiment, and a pickup in employment as reflected in the so-called survey of households. It’s only a matter of time, goes the argument, before businesses resume hiring. After all, Corporate America is now making money again, and such sharply improved profitability is presumed to allow businesses to step up and deliver on job creation. Furthermore, hiring is widely thought to be on the other side of America’s latest productivity miracle; the argument in this instance is that there’s only so much that companies can get out of their workforces before they have to start adding headcount again. Yet we’re fully 25 months into recovery and it just isn’t happening. In my view, this is not a story of those ever-fickle lags. Something new and far more powerful appears to be at work.
The global labor arbitrage remains at the top of my list of possible explanations (see my October 6, 2003 essay in Investment Perspectives, “The Global Labor Arbitrage”). It depicts the interplay of two brand-new forces — offshore outsourcing in goods and services together with the advent of Internet-driven connectivity. Such IT-enabled outsourcing has taken on new urgency in today’s no-pricing-leverage climate of excess global capacity. The unrelenting push for cost control leaves return-driven US businesses with no choice other than to push the envelope on productivity solutions. The result may well be a new relationship between US aggregate demand and employment
The “imported productivity” provided by offshoring has become especially evident in IT-enabled services — where the knowledge-based output of a remote low-wage white-collar workforce now has real-time, e-based connectivity to production platforms in the developed world. One of the clearest examples of this is a significant shortfall of job creation in America’s IT and information services industry. In the upturn of the early 1990s, employment in this industry had increased nearly 4% by the 25th month of that recovery; by contrast, in the current cycle, such jobs are down over 1% — even though the US economy is far more IT-intensive today than it was back then. At the same time, knowledge professionals’ headcount in India’s IT sector has risen from 50,000 in 1990–91 to an estimated 625,000 workers in 2002–03.
I don’t think these trends are a coincidence. More likely than not, they are the flip sides of the same coin — a shift of comparable-quality labor input from the high-wage US services sector to the low-wage Indian services sector. And, of course, this trend is only the tip of a much bigger iceberg, as offshoring now spreads up the value chain to include professions such as engineering, design, and accounting, as well as lawyers, actuaries, doctors, and financial analysts. Long dubbed the “nontradables” sector, the IT-enabled globalization of services is now in the process of transforming this vast sector into yet another tradable segment of the US economy — posing a formidable challenge to the once unstoppable Great American Job Machine.
There can be no mistaking the important implications of this jobless recovery. Lacking in job creation as never before, it follows that there is equally profound shortfall of wage income generation. Normally, at this juncture in a US business cycle expansion, private wage and salary disbursements — fully 45% of total personal income and easily the largest component of household purchasing power — are up by 8% (in real terms). Yet 24 months into the current expansion, this key slice of income is actually down nearly 1% — the functional equivalent of about a $350 billion shortfall in real consumer purchasing power.
Lacking in such internally generated income, saving-short American consumers have had to draw support from secondary sources of purchasing power — namely massive tax cuts, an outsized build-up of debt, and the extraction of cash from over-valued assets such as homes. This is a tenuous foundation of support for any economy. It has led to subpar national saving, a record current-account gap, and sharply elevated household debt service burdens — a steep price to pay in order to fund the insatiable appetite of the American consumer. A persistence of this jobless recovery will only up the ante on these imbalances — raising serious questions about the ultimate sustainability of the current upturn, in my view. For a US-centric global economy, that’s an equally disconcerting risk.
Nor can the political implications of America’s jobless recovery be taken lightly. If the economy falters for any reason between now and the upcoming presidential election and the unemployment rate starts to rise, labor-related issues could figure prominently in the political debate. That raises the risk of trade frictions and heightened protectionist perils. In the event of unexpected economic distress in an election year, the Bush administration — already quick to use steel tariffs as a politically expedient policy ploy — could well embrace the cause of China bashing, which has become popular sport in Washington today.
Targeting India as a threat to once-sacrosanct service-sector jobs is also a possibility in such an environment, as would be as assault on US multinationals that are leading the charge in offshoring; there are already rumblings of just such a backlash (see Senator Charles Schumer and Paul Craig Roberts, “Second Thoughts on Free Trade,” The New York Times, January 6, 2004). As remote and patently destructive as these measures might seem, the risks of such possibilities can only increase if job-related issues rise to the fore in a politically charged climate. Negative implications for an already weakened US dollar would be especially worrisome in that context. Downside risks to global growth would undoubtedly intensify as well.
None of this was supposed to happen. Typically, the demand response to policy stimulus elicits hiring and income creation — providing incremental injections of purchasing power that then spur a sequence of self-reinforcing cycles of more spending, hiring, and income. Such “multiplier effects” are the essence of any dynamic, self-sustaining model of the business cycle. They convert the policy-induced sources of cyclical uplift into autonomous, self-sustaining growth in the private sector. This is the core of the internal dynamics of the all-powerful US business cycle.
Unfortunately, the theory behind such a cyclical dynamic just isn’t working. Starved of job creation and wage income generation, consumers need supplemental sources of growth. To date, America’s monetary and fiscal authorities have been more than happy to comply. The Fed has provided the interest-rate support to asset markets that drives the wealth effects underpinning consumer demand. Washington’s penchant for deficit spending has also provided an extraordinary boon to household purchasing power. Yet there’s little opportunity for removing these life-support measures. To the contrary, until the economy kicks in on its own, the monetary and fiscal authorities could well be called upon to keep upping the ante. Therein lies the conundrum: With the Fed’s policy rate now near zero and America’s budget deficit at a record, the authorities are all but running out of options.
In the end, America’s protracted shortfall of jobs and internally generated income has created a new and powerful leakage in the system — a leakage that ultimately renders traditional multiplier effects all but inoperative. Not only does that draw into serious question the case for a cumulative and self-sustaining recovery in the US economy, but it could well elicit dangerous policy responses from Washington. Jobless recoveries unmask the false foundations of a cyclical upturn. That’s precisely the risk financial markets are missing. |
