Employment Reality Lies Between Poles

The 96,000 new nonfarm jobs reported Friday were significantly below consensus expectations of 145,000. The Household Survey -- heavily touted in prior months -- showed a drop of 201,000 jobs. This data, combined with increasing crude prices, led the market to tumble.

Conventional wisdom about the disappointing jobs data -- the last before the presidential election -- was that there was a little something for each candidate: The weak job creation data was bad for Bush's campaign, while the low unemployment rate undercut Kerry's argument. Expect each candidate to hammer away at their respective strong suit in tonight's debate.

When we take a closer look at the jobs data, we see the truth is more complex and nuanced than either side is letting on. The realities of the labor market fall somewhere between what each candidate is actually telling prospective voters and hinge on structural changes and tax policy.

Structural Changes

Three phenomenon have been in place long before the incumbent took office, so President Bush can hardly be blamed for their effects:

Outsourcing: The U.S. labor market has been dealing with the impact of cheaper labor abroad almost constantly for at least three decades (and possibly longer). The manufacturing process is simply much cheaper elsewhere in the world. What is so starkly different, however, is the more recent trend toward non-manufacturing outsourcing made possible by the Internet. Knowledgeable workers of all kinds -- help desks, MRI technicians, software designers -- are seeing their jobs migrate to India, most notably.

Productivity: We've seen productivity rates skyrocket over the past five years. As productivity improves, it helps to raise everyone's standard of living; it is also a large part of the dramatic improvement we have witnessed in corporate profitability. The downside is that when companies can produce more with less employees, hiring needs are considerably reduced.

Post-Bubble Environment: The bubble of the 1990s was characterized by a massive amount of over-investment, which led to the creation of excess capacity across many industries. This was especially true in the technology and telecom areas. Part of the hangover caused by the bubble's popping is that demand has not yet ramped up to meet all this excess capacity. You can see exactly how far below trend the economy is regarding industrial production and capacity utilization at the Federal Reserve's Web site. Regardless of your economic persuasion -- be it supply-sider or Keynesian -- the excess capacity post-bubble makes it especially difficult to absorb any slack in the labor market.

Unemployment Rate: Worse Than It Looks

Where the president may be more vulnerable, however, is in how he uses the unemployment rate, presently an incumbent-friendly 5.4%.

But several savvy number crunchers are now looking askance at these numbers. These economists argue that the official unemployment rate is so low because people have been increasingly dropping out of the labor force and not because of any improvements in hiring trends. The measure of this is the "labor participation rate." According to the BLS, it has fallen to 65.9% from a peak of 67.3% in January 2000. A 1.4% decrease doesn't appear very large until you apply it as a percentage of a much larger-number labor force. In a labor force of the approximately 140 million people, that 1.4% drop represents nearly 2 million unemployed people who are not showing up in the unemployment rate data.

---

Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback and invites you to send it to [e-mail].