BUSINESSWEEK ONLINE : NOVEMBER 20, 2000 ISSUE
BUSINESS OUTLOOK U.S.: Shh! Don't Wake Up the Soft Landing The Fed must tiptoe in 2001 amid slower growth and higher inflation Amid all the twists and turns and last-minute uncertainties of the historic 2000 Presidential election, two things seem clear about the economic outlook: Since any fiscal policy changes will not be enacted for another year, the path of the economy will not be any different from what was expected prior to the Florida recount. And even a year from now, the lack of any real mandate for sweeping changes in fiscal policy will limit the new Administration's ability to influence the economy. For now, at least, these two factors work in the Federal Reserve's favor. It has already pulled back on the throttle in an attempt to slow the economy from a breakneck pace to a safer cruising speed. Tighter financial conditions are already tempering demand by both consumers and businesses. The latest data from job growth to factory orders to retail activity leave no doubt that the economy has slowed a notch--or two. But outside of the malaise in manufacturing, where Fed tightening always hits hard, there is no evidence that the overall economy is anywhere near weak. Indeed, even though job growth is clearly slowing, as shown by the October employment data, labor markets remain exceptionally tight, and workers' compensation is growing at an ever-faster rate, especially in services (chart). That means 2001 is shaping up to be a period of both slower growth and rising core inflation. In the coming year, tight labor markets will have the potential to lift inflation pressures, while at the same time, softer output gains mean short-term productivity growth is likely to slow considerably. All this creates a very delicate environment in which the Fed will make policy, even as the financial markets are beginning to bet that the Fed's next move is a rate cut. FURTHER OUT, THOUGH, the Fed has to consider the uncertainties over how much and when any new fiscal thrust will be forthcoming. A substantial fiscal boost could come just at the wrong time and severely complicate the Fed's job of engineering a soft landing. The Fed might feel it necessary to counteract a big dose of fiscal stimulus with higher interest rates. That's not a problem for 2001. The new Administration can do little to interfere with the Fed's control of the economy between now and fiscal year 2002 beginning next October. And even then, the White House must still cope with a high squabble factor on Capitol Hill, given the near-even partisan split in Congress. For now, most signs suggest that the soft landing is proceeding as the Fed--and the markets--hope it will. However, despite the economy's downshift, there is as yet no sign that the labor markets are loosening up in a way that will take upward pressure off labor costs. True, payrolls added 137,000 workers in October, less than the average monthly rise of 187,000 during the first nine months of the year. But other data point to a labor market stretched thin. The jobless rate held at 3.9%. The percentage of unemployed workers who voluntarily left their last job jumped to an expansion high of 15.3%. Since August, the duration of unemployment has averaged 5.9 weeks, close to an expansion low. Moreover, 64.4% of the working-age population is employed. That's down a bit from the recent peak, but it's higher than the 1999 average. A further sign of tight labor markets is the speedup in hourly earnings of production workers. So far in the second half, pay is growing at a 4.2% annual rate, up from 3.9% in the first half and from a 3.2% pace in the second half of last year. The pickup has been especially noticeable in the private service sector, which employs 77% of all private-sector workers. So far this year, the 12-month growth rate in service pay has sped up from 3.3% to 4%, and shows no sign of slowing. Indeed, the jobless rate in the service sector is still falling. It hit 3.7% in October. THE ACCELERATION IN PAY GAINS raises the question of how much of the slowdown in job growth reflects the cooler pace of demand in the economy and how much is due to a dwindling supply of workers. For the total labor market, both sides of the equation appear to be at work, but a shrinking labor pool seems to be the chief reason for the recent slowdown in job growth for managerial and professional workers (chart). New employment for managers and professionals, about 30% of all jobs, has stalled over the past year, as job growth from a year ago is down to almost zero. However, the unemployment rate for this same category of workers, at 1.8% in October, has not risen, and compensation for managerial types accelerated in the third quarter. That suggests that the sharp falloff in job growth is not due to layoffs or any weakening in demand. So hopes of holding pay growth in this sector in line with productivity gains may be misplaced. One area where labor markets are loosening up is manufacturing. Factory payrolls were flat in October, and so far this year the sector has lost 116,000 jobs, on top of 210,000 net layoffs last year. The factory jobless rate rose to 4.1% in October, the highest in two years. A KEY FACTOR complicating the outlook for inflation and Fed policy next year is productivity. Although third-quarter output per hour rose at a strong 3.8% annual rate from the second quarter, the four-quarter growth rate slowed to 4.9% from 5.4% in the second quarter. Even if the quarter-to-quarter rate is 3% in the final quarter, the yearly pace will slip to 3.7%. While the structural trend in productivity growth has clearly shifted up, maybe to as high as 3%, the cyclical slowdown is sure to continue next year since, in the short run, productivity growth tends to follow the pace of the economy. However, compensation growth is already growing faster than the long-term growth of productivity, and it is likely to speed up next year. The measure of compensation in the Labor Dept.'s productivity report rose at a 6.4% annual rate from the second quarter, and it's up 5.1% from a year ago (chart). Unit labor costs, which have been tame during the past year, are starting to feel some upward pressure. Consequently, the overall rise in prices in the third quarter failed to keep pace with unit costs, squeezing the profit margins of some companies. That could be why inflation in the service sector is picking up. Service providers have more pricing power to cover their costs than goods producers have, since services typically face little international competition. A key point here is that the economy is in transition. The past few years have been nothing but blue sky and roses for growth, employment, inflation, profits, and stock prices. The new Administration inherits an economy whose limits are now more clearly visible. The President-elect might do well to realize that any attempt to pump up the economy in the next couple of years will most likely be met with higher interest rates by the Federal Reserve, as the Fed tries to hold the economy within those limits. By JAMES C. COOPER & KATHLEEN MADIGAN _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP					RELATED ITEMS U.S.: Shh! Don't Wake Up the Soft Landing CHART: Fatter Pay Hikes for Service Workers CHART: Is It Weaker Demand, or a Worker Shortage? CHART: Pay and Benefits Are Accelerating INTERACT E-Mail to Business Week Online

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