THE NUMBERS SEEM AT ODDS, BUT THEY ADD UP TO RECOVERY
Don't worry too much if the recent economic data look like a mixed bag of pluses and minuses. That's exactly what they're supposed to look like at the trough of a business cycle, as different industries and regions emerge from recession at different times.
In June, for example, employment decreased, but hours worked increased. In May, consumer credit fell, while retail sales rose. And May purchases of new homes declined, although housing starts advanced. On balance, the data continue to point toward recovery.
However, they do not answer the big question about what the upturn will look like. There are three scenarios: weak, strong, and short-lived. The consensus view favors a weak upturn accompanied by only modest inflation. Compared with past recoveries, when the economy posted first-year growth averaging about 6%, the real gross national product should increase only 2.8% during the next four quarters, with consumer prices rising just under 4%, according to economists in the July survey by Blue Chip Economic Indicators.
Hanging your hat on the consensus view can be treacherous. It violates an old rule of forecasting--that the consensus is always wrong. And economists have tended to underestimate the strength of past recoveries. However, the numbers for May and June make a strong case that, this time, the consensus may be right.
The June employment report was one of those mixed bags. Nonfarm businesses lengthened their workweek for the second consecutive month, to 34.5 hours from 34.3 hours in May and 34 hours in April. That's a classic recovery pattern. Companies typically add to their work time before bringing back laid-off employees.
Because of those increases, the drop in June payrolls was not so worrisome, but the failure of employment to keep expanding is a sign that the economy continues to struggle. Jobs fell by 50,000, after a revised gain of 119,000 in May. That increase was originally reported as 59,000, but hiring at stores and companies providing personal services was stronger than first thought. The large May advance could mean that April marked the trough for employment during the recession (chart).
The unemployment rate edged up from 6.9% in May to 7% in June--the highest since 1986. It would not be surprising to see the jobless rate rise further this summer. Joblessness typically grows at the beginning of a recovery because the pickup in business activity draws more people into the labor markets before companies are ready to refill positions.
But this time, job seekers may be pounding the pavement longer than in past recoveries. Companies will have a stronger incentive to increase the hours of their workers and invest in new machinery rather than to add new employees. That's because businesses, particularly in the service sector, face an acute need to raise productivity of existing workers in order to cut costs and improve profitability, which has been sinking since 1989.
Because companies are stretching work hours, for example, the number of people holding part-time jobs has dropped sharply since April. However, that does little to take up the slack in the nation's labor pool.
That slack--and the prospect that it will go away only slowly--is a big reason why wage growth is unlikely to fuel inflation in coming months. Average hourly earnings jumped 0.6% in June, but that partly reflects the month's big increase in overtime, which is paid at a higher rate. In the second quarter, wages were up only 3.4% from the same quarter of 1990. That's down from a 4% pace during the previous four quarters (chart).
The productivity gains that typically accompany recoveries will also help the outlook for inflation. Faster growth in productivity will offset the growth of wages and allow a slowdown in unit labor costs. That will give companies more pricing flexibility to repair damaged profit margins, but at the same time, lower unit costs will help hold back price hikes.
Looking outside the labor markets, it is also hard to see any fundamental upward pressure on prices. Commodity prices were still falling in late June. The stronger dollar is holding down import prices. And money growth is too slow to cause worry that it might fuel price hikes. Continued slack in the labor markets only assures the sanguine outlook for inflation.
Service industries, in particular, are wrestling with a productivity problem, because output per hour worked in this sector hardly budged during the second half of the 1980s. The hiring slowdown among service companies is the sharpest since the 1957-58 recession. During the past year, service jobs have declined by 0.4%.
Overall, the private service sector added 32,000 jobs in June, on top of the 62,000 added in May. But all of the June gain and most of the May increase came from the health care and business-service industries.
Wholesale and retail trade and financial industries continued to lay off workers, although the workweek increased in all three sectors. Government jobs fell by 11,000 in June, and the fiscal troubles in many states and cities suggest further declines in coming months.
Manufacturers also continued to pare payrolls. Factory jobs slipped by 59,000, to 18.4 million. That's the lowest payroll level in eight years. Payrolls in the machinery, electronics, and transportation-equipment industries took big hits last month.
The factory workweek, however, grew by 24 minutes, to 40.8 hours in June. Overtime increased to 3.7 hours from 3.4 hours in May. The rise in the workweek suggests that industrial output rose in June for the third consecutive month. However, a sustained advance in production will depend critically on consumer spending. And the slower companies are to add workers to their payrolls, the smaller the gains will be in consumer incomes.
In the face of weak income growth, consumers have a real problem when it comes to leading the recovery. They have only meager resources to pay off their huge debts, rebuild their historically low savings, and find enough left over to spend. Judging by the latest report on consumer installment credit, reducing debt seems to be a top priority.
Consumers have paid off more debt than they took on in six of the past eight months (chart). In May, installment credit outstanding fell by $626 million, to $733 billion. Since last October, debt has fallen by an average of $320 million per month.
Consumers seem especially determined to pay off their car loans. Auto credit has fallen in 14 of the past 15 months. And in May, car loans outstanding dropped by $3.2 billion, the largest monthly decline on record. Revolving credit, largely charge cards, continued to expand in May, but even this category has slowed sharply. During the past year, revolving debt has grown 8%, compared with the 15% pace of a year ago.
Consumers' new distaste for debt probably reflects their persistent concerns about jobs and incomes. Against that backdrop, mortgage rates will probably have to be extremely attractive before people commit themselves to the purchase of a new home. The trouble is, fixed mortgage rates have risen, from 9.25% in late February to 9.67% in late June (chart).
Not surprisingly, sales of new single-family homes fell 3.3% in May, to an annual rate of 474,000, the lowest pace since January. The falloff was particularly sharp in the South. The drop raises new questions about how much lift the housing recovery will provide for the overall economy, particularly since the glut of existing apartment buildings is already exerting a record drag on overall housing starts.
To be sure, the data add up to a recovery. But until companies show more willingness to expand their payrolls, and until consumers prove that they have the wherewithal to support a lasting upturn, the modest expectations of the forecasting consensus seem justified.JAMES C. COOPER AND KATHLEEN MADIGAN