Economic Trends
Edited by Michael J. Mandel
The Next to Feel the Ax
With inventories almost 5% below where they were last year and employment down more than 7%, U.S. manufacturers have aggressively cut costs. That has positioned them to take advantage of any economic upturn.
Unfortunately, the same can't be said for some key high-wage service industries. Anticipating a short and mild downturn, the banking, consulting, legal advice, and accounting industries have all expanded their payrolls over the past year, adding about 55,000 jobs, according to the Bureau of Labor Statistics (chart). After struggling to find qualified workers in the 1990s, "companies don't have a desire to reduce head count, because when the upturn happens they won't be prepared," says Michael F. LaPorta, global leader for insurance at Deloitte Consulting LLC.
The problem: Even if the recession ends soon, these industries may be stuck with overcapacity and falling profit margins. Banks, for example, expanded their profitable mortgage-lending operations in 2001 as falling interest rates fueled demand for home loans and refinancing. But with the Federal Reserve unlikely to cut rates again, mortgage demand should contract this year, forcing job cutbacks. Moreover, rising unemployment will boost defaults for consumer debt, hurting bank profits and increasing the pressure for cost cuts.
Similarly, excess workers remain in accounting and consulting, where employment grew at a 6.5% annual rate in the second half of the 1990s. In consulting, "all the firms have more capacity than they need," acknowledges Deloitte's LaPorta. And accounting firms are under siege in the wake of the Enron Corp. debacle, so consolidation and job cuts are likely.
Because these industries tend to employ high-wage workers, such cuts could have a large economic impact. Taken together, banking, consulting, legal services, and accounting make up almost 7% of total private U.S. payroll outlays. As a result, widespread layoffs in these services could hurt consumer spending and counteract the gains from an expansion in manufacturing.
To be sure, some large service industries are thriving. Health-care revenues and employment, which showed a 299,000 gain over the past year, will continue to grow as an aging American population spends more on medical care. But that still may not be enough to counteract the drag from the high-wage services.
This Economy Is No Charade
Has fraudulent accounting drastically overstated the profitability of the U.S. corporate sector in recent years--and thus the health of the economy? No it hasn't, says Steven Wieting, a senior economist at Citigroup's Salomon Smith Barney unit in New York.
Wieting says he investigated the question after receiving inquiries--particularly from foreign investors--in the wake of the Enron accounting scandal. Contrary to investors' fears, he says analysts are on solid ground in using the operating income of the Standard & Poor's 500 companies as a measure of corporate profitability. He says the measure has risen and fallen in the same pattern as the overall economy going back at least as far as 1970. The more conservative measure of profits--net income under generally accepted accounting principles (GAAP)--is actually a less effective indicator because it's affected so much by one-time events such as write-offs, Wieting says.
For instance, manufacturing production fell a sharp 7% last year. From past downturns, that should mean a 20% decrease in corporate profits--and that's just how much S&P operating income did fall. In contrast, net income under GAAP fell 50% because of write-offs, exaggerating the economic weakness. The distortion of GAAP is likely to be worse in 2002, with write-offs possibly wiping out the entire net income of the S&P 500, Wieting predicts.
As for the accuracy of debt measurements, the Federal Reserve bases its numbers on data from lenders rather than borrowers, so it's not misled by companies' attempts to hide debt off the balance sheet, as Enron Corp. did. Thus, even if a company manages to obscure its responsibility for repaying a certain debt, it can't make the debt disappear from the overall economy's ledgers.
Do Housing Subsidies Work?
With home prices continuing to rise, affordable housing for low-income families is a pressing need. Yet subsidies have shrunk as a percentage of the economy in recent years. Critics have argued that government-funded, low-income housing only replaces units private landlords would have created otherwise (chart).
A study of the impact of housing subsidies from 1977 to 1996, including both government-issued rent vouchers and public construction of new buildings, provides ammunition for both opponents and supporters. The authors, Todd Sinai and Joel Waldfogel of the Wharton School, find that subsidies, while reducing privately funded development, also increase the low-income housing stock. They calculate that government funding to build three new low-income housing units displaces two private units, on average. This adds one more unit, on net, to the total low-income housing stock. Thus, building 30,000 new low-income units will provide new dwellings for 10,000 low-income families, or less crowding for people who already have homes.
The authors also find that giving poor people housing vouchers seems, on net, to create more places to live than directly funding the construction of public housing. The reason may be that vouchers are more likely to reach the poorest part of the population.
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Corrections and Clarifications
In the chart that accompanied the article ``Do housing subsidies work?''
(Economic Trends, Feb. 18) a decimal point was dropped from the vertical
axis. A corrected chart appears below, updated with the latest data.
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Copyright 2002 , by The McGraw-Hill Companies Inc. All rights reserved.
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