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Jobless recovery in US — World staring down a gun barrel

V. Anantha Nageswaran

If neither hiring nor wage growth improves in the course of this year, the American economic recovery would be affected, with deep and harmful consequences for the global economy. There will be greater risk of protectionism, trade wars and `beggar thy neighbour' monetary policies, says V. Anantha Nageswaran.

INDIA has become the epicentre of the debate in the US about jobless recovery and whether such a recovery is sustainable. Guns are being trained on the offender should the recovery flounder on the lack of job creation. There is more than a touch of paranoia to the discourse. The Senate inserted a clause in a spending Bill that companies cannot outsource Federal contracts to other countries. Some US States have done so and more might so follow suit.

Steven Roach, one of the perennial prophets of doom on the US economy puts the matter in perspective: "The most widely cited figures come from the IT consulting group, Forrester, which estimates that the overseas outsourcing of IT processing jobs will climb from about 400,000 today to about 3.3 million by 2015. If that number is correct, the loss of about 300,000 jobs per year is hardly devastating for a US labour market that currently employs some 130 million workers."

However, although globalisation of jobs may not be the reason, the reaction of America's workers may be justified. This recovery has been a peculiar and disturbing one for them. It is just that India is caught in the crossfire because an external target is easier to coalesce around in an election year.

No joy in this economic recovery for American labour

First, the facts: Since the third quarter of 2001, when the last recession officially ended, until the end of December 2003 (data for January are due on February 6), the total number of workers on non-farm payroll has shrunk more than by 1.4 million. The median duration of unemployment — the number of weeks a worker, having lost his job, remains unemployed — has risen from 7.2 weeks to 10.4 weeks during the same period. The unemployment rate has jumped only marginally from 5.0 per cent to 5.7 per cent. That is because nearly two million workers have left the labour force. That is, they have voluntarily stopped looking for jobs. Some of them might have become self-employed. But it is possible that most have not been able to find jobs. If we account for this fact, the unemployment rate would be at 7.5 per cent.

During the same period, the labour force participation rate has come down from 66.8 per cent to around 66.0 per cent. That is, the growth rate in the population (America labels its the strength of its citizens as `non-institutional' population) has exceeded the rise in the labour force. Simply put, America has not created enough jobs since the recession ended.

The Economic Policy Institute provides more ammunition to American workers:

(1) Job creation, to the extent it is happening, is taking place in lower wage industries. In 48 of the 50 states, jobs in higher-paying industries have given way to jobs in lower-paying industries since the recession ended in November 2001. Nationwide, industries that are gaining jobs relative to industries that are losing jobs pay 21 per cent less annually. (Source: http://www.epinet.org/content.

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(2) Further, in the last four quarters, real weekly earnings of workers in the low- and middle-income category have declined whereas it has increased marginally for those `at the top of the wage scale'.

Corporations have never had it so good

Whether or not outsourcing becomes a genuine net job-drainer for the US economy in the years to come is a matter of conjecture. For now, it is not the villain. Where does the problem lie? Well, facts would support the case for Marxian revolution in the land of capitalism. Just as American workers have never had it so bad in a recovery, American corporations have never had it so good. If a picture is worth thousand words, the chart is worth a few books!

Corporate profits have surged way ahead of the average post-War recession recoveries while employment has gone the opposite way. What lies behind this? One answer is obvious in the chart itself. Decline in employment has caused wage growth to slow down to a crawl too and, hence, profits have risen. This is not a conjecture. The rise in average hourly earnings has slowed to just above 2 per cent from 4 per cent two years ago. Macro-economic policy has played its part too. The Federal Reserve lowered the short-term interest rate to such levels that firms could substitute high interest bearing loans with cheaper loans. The government lowered corporate tax rates, allowed accelerated depreciation write-offs and gave tax breaks for capital expenditure. At the margin, continued outsourcing of manufacturing to China and service sector jobs to India too played their part. The all-important question is whether the renewed corporate health would finally lead to job creation. The author believes that prospects do not appear bright. Reasons are several.

More jobs may not be created yet

First, pressures of a competitive market place continue to keep the focus on costs. Second, pressure from Wall Street for ever-rising profits has not diminished. Wall Street analysts continue to increase estimates for profits every quarter unmindful of whether the economic or profit cycle is at an advanced stage or early stage. This profit cycle is an advanced one, according to many observers. Profits have continued to climb for about eight quarters. The final quarter of 2003 would make it the ninth. Only ever-rising profit estimates would justify analysts' `Buy' recommendations on stocks at lofty multiples.

Third, boosting profits does no harm to managerial compensation, as the practice of awarding stock options remains widely prevalent. Only few corporations have offered to end that practice. Fourth, the erosion of unionised labour power has left labour bargaining too weak to extract more concessions from corporate management. The decline in labour's bargaining power might have ended but no definite improvement is yet on the horizon. Exaggerating the fear of losing jobs to India and China does no harm to the objective of keeping workers on the defensive. Fifth, accelerated tax concessions for capital expenditure are due to expire at the end of 2004. Hence, fiscal incentives are slanted towards capital expenditure and not hiring. Finally, pensions and benefits continue to remain big concerns for corporations.

Benefits costs are rising at a rate of 6.0 per cent from a low of around 2.0 per cent — 3.0 per cent in the five years between 1996 and 2000. Estimates of unfunded pension liabilities range from $200 billion to $260 billion. Despite equity market returns of around 20 per cent last year, the pension liabilities funding gap has not shrunk because interest rates are, on average, still lower than in previous years. Low interest rates mean that the present value of future pension liabilities is high. Increasing the returns on pension fund assets in a low interest rate environment is riskier as funds have to go for long duration assets and emerging market bonds. If equity market returns do not match assumed returns, the gap gets wider. Chances of the US equity market repeating the performance of 2003 are not high because valuations are already high. The only way out is for corporations to raise their contributions to pension funds. Hence, corporations flush with record profits might have other uses for it than boosting capital expenditure or hiring new workers.

Higher budget deficits and a weaker dollar are likely

If neither hiring nor wage growth improves in the course of this year, then what happens to the American economic recovery? This author fears, as do Steven Roach and Richard Berner of Morgan Stanley, that the consequences for the US economy and the global economy would be far-reaching, deep and harmful (`Debating the jobless recovery', Morgan Stanley Global Economic Forum, January 30, 2004: www.msdw.com/gef).

Despite lower interest rates of the last three years, household balance-sheets have not improved. They took on more debt at low interest rates. Since households took on more debt, their ability to service debt has not improved but stayed constant at elevated levels. There is no cushion to absorb higher interest rates.

Since the Federal government budget balance swung from surplus to deficit, more than offsetting the improvement in the corporate sector financial balance, the current deficit has widened further. If households do not see their incomes rise and cannot take on further debt, then the Federal government has to continue to run deficits.

While it raises long-term concerns, in the short-term, that is the only recourse left. The current account deficit would widen further to 6-7 per cent in the next few years. Funding the current deficit with low bond and equity yields and a disinclination to go back to thrifty ways means that a weaker dollar is the only recourse. It would raise American share of global exports and make imports costlier.

As would be exchange rate wars and trade protectionism

However, the weakness of the US dollar would test the limits of patience of other governments. Weak economies feel that strong currencies hurt more than help. Now, Europe feels that Asian governments are preventing their currencies from absorbing US dollar weakness. They are sure to raise this concern at the meeting of G-7 finance ministers next week.

Later, both Europe and Asia would feel that they have done more than they could, given their fragile domestic economies. There will be greater risks of protectionism, trade wars and `beggar thy neighbour' monetary policies. Domestic credit growth would rise, therefore, in many countries, creating asset bubbles in its wake.

The world is staring down the barrel of the gun. It is possible that American corporations would step up hiring massively and thus either postpone or entirely avoid the previously mentioned doomsday scenarios.

However, it would be a mistake for investors to bet on that outcome. Diversification away from US dollars and maintaining a constant exposure to gold are two of the logical investment decisions that investors can take now to shield themselves from the consequences of a possible unravelling of the (lopsided) American economic recovery and global dependence on it.

(The author is Director, Global Economics and Asset Allocation in Credit Suisse, Singapore. The views are personal. Feedback can be sent to nageswar@singnet.com.sg)

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