Judged solely by the labor markets, it would be easy to conclude that the U.S. economy is in a recession. Ordinarily, back-to-back job losses of 357,000 in February and 108,000 in March are seen only during periods of downturn. But these are hardly ordinary times.
Clearly, the runup to war and its uncertainties took a heavy toll not only on the labor markets but also on the economy generally in the first quarter. In addition to the slumping job market (chart), surveys of both industrial and service-sector activity collapsed in March, and consumer spending looked unusually shaky. The widespread softness raises a crucial question: How much of the weakness is war-related and how much is not?
The answer is about to become clear. Given the news that U.S. troops are roaming freely about in Baghdad and that the British now control Basra, the much-hoped-for "quick war" scenario is back on the front burner. Under that outcome, the veil of uncertainty over the economy is supposed to lift, encouraging executives to boost capital spending and hiring. Consumer confidence is supposed to recover, with households returning to their free-spending ways. Thoughts of recession will quickly fade.
Wall Street readopted this outlook as soon as U.S. troops were on the outskirts of Baghdad. That relieved fears of a military quagmire, and the Dow Jones industrial average rose 293 points from Mar. 31 through Apr. 2. Analysis has turned toward pecuniary pursuits, such as which companies will benefit from the rebuilding and how low can postwar oil prices fall.
BUT WITH WAR WORRIES FADING, investors have quickly refocused on the economy's problems, including overcapacity, new accounting scandals, and budget woes, especially on the state and local levels. Despite positive news from Iraq, the stock market gained no additional ground in the week after its early April surge. What concerns investors is that troubles unrelated to war will keep this recovery at risk, even after the last statue of Saddam Hussein has been toppled.
These renewed worries come just as the first-quarter earnings season begins. Already, companies are warning about profit shortfalls, partly because demand was dismal. Real consumer spending fell in January and February, and poor weekly reports on March store sales, as well as weak vehicle sales over the course of the winter, indicate real household purchases grew at an annual rate of only about 1.5% last quarter. And a drop in capital-goods orders in February suggests business spending plans remain on hold until the war's resolution.
Not surprisingly, the weakness in business activity has fallen back on the nation's workforce. True, some of the layoffs were war-related. Consider travel industries such as airlines, hotels, restaurants, and amusement parks -- areas most vulnerable to prewar jitters and terrorism fears. These sectors make up less than 10% of all jobs, but since January, when war worries began to intensify, they have accounted for nearly half of all layoffs (table).
But other industries are also shedding workers, suggesting the economy is struggling with problems beyond the war. For instance, over the past three months, only 38.9% of private industries have added workers, the lowest hiring rate in over a year. Meanwhile, budget woes are forcing state and local governments to pare payrolls. In March, local governments cut 34,000 jobs, mostly in education. And more layoffs could happen, unless tax revenues pick up.
ALL THIS IS NOT TO CONCLUDE THAT a postwar spurt in demand is out of the question. But without full participation from the labor markets, the surge will not last. The recovery's speed will probably build only gradually over the rest of 2003. That could reverse the stock market's postwar rally, and job seekers may be disappointed down the road.
That's because businesses remain keen on lifting productivity rather than adding workers. Overall hours worked last quarter fell at a 0.4% annual rate from the fourth quarter, implying that, even if the economy grew only 1.5%, as the consensus expects, productivity rose about 2%. The longer companies focus on productivity, the longer it will take for jobs to bounce back.
On the plus side, companies are using some of their gains in productivity to support the salaries of their remaining workers. Hourly wages for production workers edged up 3.1% in the year ended in the first quarter. That's just above the inflation rate, even when including last quarter's jump in fuel costs. As long as real incomes are growing, households have the means to keep spending. The danger is that consumers, worried about their job security, may decide to save more and spend less, a recipe for recession.
GROWING JOB JITTERS might seem misplaced, since the unemployment rate has held steady. March's rate of 5.8% was the same as in February, and the first-quarter average was barely higher than it was a year ago.
But the jobless rate very likely understates the weakness in the labor markets. Since the recession began two years ago, the percentage of the working-age population that is in the labor force has shrunk from 67.1% to 66.2% (chart). The decline is from the post-World War II highs hit during the late 1990s, when changes to welfare programs and the overall boom in the economy drew many otherwise marginal workers into the labor force. A drop of about 1% represents 2 million people who have dropped out of the workforce, presumably because they do not think a job is available. If these people were still seeking work, the jobless rate in March would have hit a 10-year high of 7.1%.
Once the war ends and companies begin hiring again, many of these people may return, perhaps rapidly, to the labor force to start looking for work. That suggests the unemployment rate could pop up over 6% later this year, even as the recovery shifts into a higher gear.
The weakness in the labor markets adds pressure on the Federal Reserve to jump-start the recovery. Normally, job losses like those in February and March would have pushed the Fed into an intermeeting interest-rate cut. But policymakers seem to believe the current weakness is war-driven, which means they will wait for stronger evidence of underlying problems before loosening monetary policy any further. And since the federal funds rate is already at 1.25% -- unheard of at the start of a recession -- it's possible the Fed would use unconventional methods, such as buying long-term Treasury bonds to bring down long rates, to boost the economy.
But the unanswerable question right now is whether the Fed will have to resort to such measures. After months of business activity being held back by the talk of war, the economy remains hampered by a separate set of factors. The U.S.-Iraq conflict must be resolved, however, before the Fed, or anyone else, can know just how weak this economy really is.
By James C. Cooper & Kathleen Madigan
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