Zeev's Turnips Patch-No Politics (ZEEV)

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*** Stephen Roach (1-9-07) ***


Global
The End of Labor

Jan 09, 2006

Stephen Roach (New York)

America’s once mighty job machine is struggling as never before. The combination of subpar job creation and real wage stagnation puts extraordinary pressure on the income-generating capacity of the world’s most aggressive consumer. Of course, you’d never know that from the spin that followed the release of the latest monthly labor market surveys of the US Bureau of Labor Statistics. From Washington to Wall Street, the verdict was nearly unanimous -- all is fine on the US labor market front. Nothing could be further from the truth.

The overall pace of job creation in December (108,000) was half that expected by the market consensus (200,000). Consolation for this miss was taken from a big upward revision to the original job count in November (from 215,000 to 305,000). As if that’s all that mattered. Never mind that the two largest contributors to this upward revision were temporary hiring agencies and the so-called leisure industry (mainly restaurants); the basic point is that the underlying hiring trend is decidedly on the wane. You can’t tell that by fixating on the vigor of average gains in November and December -- they were hugely distorted by a post-Katrina rebound effect. The four-month average, which covers the storm-related disruption -- which held employment growth to a mere 21,000 in September and October -- and its subsequent rebound, was a mere 114,000. That’s the only accurate way to measure the underlying trend in job growth during this storm-distorted period, and it represents a decided shortfall from the more robust pace of job creation that had prevailed over the preceding 18 months (197,000 per month).

But context is key in understanding that subpar job creation is now the norm in America. The US economy has just completed the 49th month of an expansion that began in November 2001. At this juncture in the four long cycles of the past -- the ones that began in 1961, 1976, 1982, and 1991 -- job growth was cruising ahead by about 210,000 per month. Moreover, in those earlier cycles both the economy and labor market were considerably smaller than is the case today. Adjusting for the scale effect, the 210,000 cyclical norm from earlier cycles would translate into about 325,000 per month in today’s economy. On that basis, the latest four-month average of 114,000 on the hiring front looks all the more pathetic -- literally 35% of the pace that would be expected at this phase in a normal business cycle expansion. Of course, this has never been a normal business cycle expansion insofar as hiring has been concerned. For the first two years, it was the infamous “jobless recovery.” While the pace of hiring has picked up somewhat in the subsequent two years, growth has been chronically weak when compared with any expansion of the past 40 years. Had hiring followed the trajectory of the previous four expansions, our calculations suggest about 11 million more workers would have been added to nonfarm payrolls by now.

Unfortunately, for the American worker, this jobless recovery has also been “wageless” -- characterized by an extraordinary stagnation in real wages. This also shows up loud and clear in the just-released December employment report -- a 3.1% increase in average hourly earnings, which falls short of the 3.4% CPI-based reading of inflation over the 12 months ending in November. The apologists would tell you to strip out food and energy in measuring real wages, or argue that wages must be judged against the likely moderation in headline inflation that is bound to occur once the energy shock subsides. I’m not sure wage earners would buy that logic as they now write their checks for this winter’s home heating bills. Moreover, the private industry wage component of the Employment Cost Index -- long thought to be the most comprehensive measure of worker pay rates -- decelerated to just a 2.2% increase in the 12 months ended September 2005. Not only is that virtually identical to the underlying rate of core inflation -- thereby providing further validation to the stagnation of real wages -- but, as Dick Berner recently noted, it is the smallest annual increase in the 25-year history of this wage series (see his 6 January 2005 dispatch, “Will the Real Wage Measure Please Stand Up”).

The combination of a relatively jobless and wageless recovery puts tremendous pressure on American households. This shows up loud and clear in the compensation component of the personal income data. This is the broadest measure of labor income paid out by the private economy -- including not only wages and salaries but also social security, healthcare, pensions, insurance, and other benefits. In 3Q05, private sector compensation accounted for fully 65% of total disposable personal income in the US -- by far, the major driver of the internal income-generating capacity of the US economy. Over the first 48 months of the current economic expansion, private sector labor compensation has risen only 11% in real terms -- far short of the 19% gain at a comparable phase of the past five expansions. Had this gauge of labor income followed the trajectory of earlier cycles, our estimates suggest that real compensation would have been some $335 billion higher than is the case today. In short, a jobless and wageless labor market has left income-short American workers strapped as never before.

These aggregate numbers mask well-known disparities in the income distribution by obscuring the increasingly important distinction between high- and low-quality jobs. The politicians have been quick to boast of the creation of 2 million jobs by the Great American Labor Machine in 2005 (actually 1.779 million on a December 2005 over December 2004 basis). What they didn’t tell you was that fully 43% of that hiring was concentrated at the low end of the job spectrum -- industries like employment agencies, restaurants, and healthcare and social assistance. Moreover, another 24% of the hiring over the last 12 months was accounted for by financial services and the bubble-driven construction and real estate industry -- not exactly America’s more stable sources of job creation. Beneath the surface, the disconnect between jobs and the quality of economic growth is every bit as profound as it is at the aggregate level.

The deeper question is, why -- why has the US labor market broken the mold of the past? At work, in my view, are the unmistakable pressures of an increasingly powerful global labor arbitrage (see my 6 October 2003 introduction of this topic, “The Global Labor Arbitrage”). Why else would there be such a stunning and protracted shortfall of job creation and real wage increases? It has become conventional wisdom to heap the blame for these developments on the productivity story. I have never bought that explanation. America’s post-World War II experience has been punctuated by several periods of sustained rapid job creation that coincided with rapid productivity growth -- the 1960s and the latter half of the 1990s are important cases in point. Moreover, even if that relationship has changed, it is hard to explain the extraordinary disconnect between stagnant real wages and surging productivity. A key premise of economics is that workers are ultimately paid their just reward as determined by their marginal product (i.e., productivity growth). Yet that most assuredly has not been the case in the current expansion.

Globalization and the powerful cross-border labor arbitrage it has spawned has turned the US labor market inside out. The manufacturing share of US employment hit another record low as 2005 came to an end -- down to 10.6% of total nonfarm payrolls, or about one-third the share prevailing as recently as 1970. At the same time, employment and compensation is being squeezed in services as well, where offshore outsourcing is moving rapidly up the value chain. The speed of this transformation is what’s so daunting. Just five years ago, white collar outsourcing was confined to data processing and call centers; today, courtesy of IT-enabled connectivity, it has moved to the upper echelons of the knowledge-worker hierarchy -- software programming, engineering, design, doctors, lawyers, accountants, actuaries, business consultants, and financial analysts. The Internet is living up to its reputation of being the most disruptive technology in the history of the world.

The implications of these developments are profound. Long lacking in income support, the spending-addicted American consumer has turned to equity extraction from asset holdings in order to support the habit. According to Federal Reserve estimates, the current pace of home equity extraction was around $600 billion in 2005 -- more than enough to compensate for the $335 billion shortfall of real labor income generation noted above. But if the housing market softens and financing costs rise -- both quite likely, in my view -- equity extraction will fade and over-extended American consumers will then have little choice other than to bring spending and saving back into more prudent alignment with income.

That underscores the potential for a long-deferred and important transition in the US -- away from the newfound joys of the Asset Economy back to the Income Economy of yesteryear. Such a transition undoubtedly spells slower consumption and real GDP growth over the foreseeable future -- a downshift that may already have triggered a slowing in the underlying pace of hiring over the past four months. In that context, further tightening would most likely be out for a deflation-phobic Bernanke Fed, bonds should rally, stocks could be hit by an earnings shortfall, and the dollar will likely fall further. Only a spontaneous and powerful regeneration of labor income would allow the US economy to avoid such an endgame -- an outcome that would imply nothing short of an unwinding of the global labor arbitrage. Barring a dangerous outbreak of protectionism, such a reversal is highly unlikely, in my view.

Globalization imposes a new paradigm of competitive survival on the high-cost developed countries of the world. America, with its open and flexible system, is on the leading edge of feeling the heat and responding to these competitive pressures. It’s not just jobs and real wages, but also the legacy costs of healthcare and pensions for retired and existing workers. Recently, IBM and Verizon joined the ranks of those in Corporate America who have frozen pension benefits. There can be no mistaking such telltale signs of the global labor arbitrage: Companies in high-wage economies see little choice other than to rewrite social contracts as the means for competitive survival. For the United States, it’s the end of labor as we once knew it.

http://www.morganstanley.com/views/gef/archive/2006/20060109-Mon.html