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Instinctively, most market-watchers want to classify any economic data release as bullish or bearish. This knee-jerk, one-dimensional perspective can severely limit insights into a multidimensional economy.
The current situation is a case in point. Kick-started by massive stimuli, the economy is evidently poised for stronger growth in the second half. Earnings are improving, the
is determined to keep rates down, and if the jobs numbers are bad, no problem -- aren't they lagging indicators?
Well, not exactly.
Contrary to popular belief, employment is a roughly coincident indicator. On average, it peaks and troughs around the same time the business cycle does.
A trough in the jobless rate is actually a
indicator of a recession, with an average lead-time of seven months. If you find that hard to believe, just check the historical record.
But because of the widespread misconception, anyone pointing to the rising jobless rate as a harbinger of recession was considered uninformed in early 2001 because, of course, everyone else just
it was a lagging indicator of the 2000 slowdown. I vividly
remember my frustration at the ability of so many observers to ignore reality, with recession staring us in the face.
The jobless rate does tend to lag behind the end of a recession, but that's mainly in slow recoveries and sometimes when the economy is undergoing great structural change.
For the past year and a half, I've been predicting a subpar recovery, which is precisely what we got. Back in May, when many were still worried about a double-dip recession and deflation, I
emphasized that neither was on the horizon. The stock market has now rallied in recognition of that fact, and even the bond market is having second thoughts about whether deflation is truly a danger.
That brings us to the current state of the recovery and the jobs numbers -- because they're telling us a very important story. Are we finally going to get that second-half V-shaped recovery we've been promised for three years?
The Real Giant Sucking Sound
Virtually all of the coincident indicators used to determine the end of a recession have been rising since the end of 2001, and that's when the recession ended. GDP, industrial production, income, sales and the household survey's tally of jobs all hit their lows around that time. The key indicators have been recovering -- except nonfarm payroll jobs, which has some experts wondering if the recession has ended at all.
To understand what's going on, it's useful to break down the employment numbers. Specifically, let's look at the two biggest components: Service-sector jobs, accounting for 83.0% of the total; and manufacturing jobs, making up 11.3%.
Click here for larger image.
The chart shows quite clearly that, after remarkable growth in the late 1990s, service-sector jobs peaked in March 2001 when the recession began, and bottomed in December 2001 when the recession ended. Since then, service-sector employment has been rising slowly, but steadily.
The chart also shows manufacturing jobs -- on the same scale. They peaked in March 1998, exactly three years before the recession began and manufacturing employment started plunging. The problem is, it's still plunging, overwhelming the steady gains in service-sector employment.
It was no different in June: 56,000 jobs were lost in manufacturing, while 30,000 jobs were lost in all. That's the real reason why nonfarm employment keeps falling, even though the economy has been growing for a year and a half. And that's why we now have the longest stretch of rising joblessness in the postwar period, along with the lowest number of people employed in manufacturing since 1958.
What it means is that the recession really did end in late 2001. The confusion about the end date of the recession comes purely from the persistent loss of manufacturing jobs. So what's the matter with manufacturing?
It's a complex issue, but the key is the overcapacity created by the first global recession in a generation, triggering deflation in the prices of tradable goods. With prices falling, manufacturers are forced to cut costs to survive.
An easy way to do that is to outsource production to China, forcing competitors to follow suit or go out of business. That's why, over the past couple of years, there's been a dramatic acceleration in the movement of manufacturing capacity to China. As China moves rapidly into higher-end products, factories and jobs vanish not just from the U.S., but also from many other countries that simply can't compete.
During the last jobless recovery, presidential candidate Ross Perot talked of the "giant sucking sound" of U.S. jobs moving to Mexico as a result of NAFTA. What followed, of course, was the longest expansion in U.S. history.
A decade later, factories and jobs are moving from Mexico to China, whose exports to the U.S. just overtook Mexico's. The suction is so powerful that Mexico often can't compete despite its physical proximity to the U.S. and the advantages of NAFTA. As a result, Mexican
factories have lost more than 200,000 jobs since 2000. That's the
giant sucking sound.
Of course, as the data show, U.S. productivity growth has remained strong, meaning that firms are able to grow production without hiring new workers. What about those investment incentives in the president's "Jobs and Growth Package"? Well, if companies invest in productivity-enhancing equipment to help them compete, they'll be able to make do with even fewer workers. The result could be strong productivity growth, but not much job growth.
A Lopsided Recovery
The growth rate of ECRI's
Weekly Leading Index is now the highest it's been since summer 1999. So, sure, GDP growth will be noticeably stronger in the second half of 2003.
That should have some positive impact on job growth, especially in the service sector. But manufacturing is likely to remain weak as industrial capacity moves rapidly to China, continuing a major structural shift in the U.S. economy.
Tax cuts and lower interest rates can't really do very much about this shift in manufacturing, which is the key to this jobless recovery. At the end of the day, China is simply more competitive in a fast-growing list of industries.
A similar dynamic is driving back-office jobs to India, but relative to the size of the service sector, such job losses represent barely a trickle. In comparison, the disappearance of manufacturing jobs is a raging torrent.
What's to be done? To quote a recent
Columnist Conversation posting by Howard Simons, "You can import the talented workers, or you can export the work, but you can't keep the work in a higher-cost zone."
On the same subject, I can't do better than to
quote Paul Kedrosky because I agree completely:
"I have immense sympathy for those affected ... but the current hollowing-out ... is not a short-run down-market phenomenon. It is part of the globalization of trade ... and it is happening very quickly. And in the absence of revenue drivers, companies ... are having to use price increases and cost reductions to maintain margins. "From an investment standpoint, there are a couple of angles. One, you can look for vendors that are more aggressive than others in outsourcing, under the premise that they will see the most significant cost reductions. Two, you can look for providers of ... outsourced services who are the beneficiaries."
Since February 2001, the economy has lost 2.6 million jobs, 90% of them in manufacturing. I don't know when the hemorrhaging of manufacturing jobs will stop, but it may not be soon. In any case, I'll keep an eye on ECRI's Leading Employment Index, which remains weak.
ECRI's founder, Geoffrey H. Moore, created that index, along with the Future Inflation Gauge, because he understood the multidimensional nature of the economy, which from time to time leads to jobless recoveries or stagflation, neither of which is exactly bullish. And what those indices are predicting today is an extended jobless recovery.
That's not exactly a bullish or a bearish scenario. What we'll get is a lopsided recovery -- a pickup in GDP growth, but not so much in job growth; strength in services, but not as much in manufacturing.
Many families will suffer as the job losses continue, but eventually this process of creative destruction will lead to new job creation. In the meantime, it will reward not so much the pure bulls or bears, but the investors who understand the rapidly changing economic landscape.
Anirvan Banerji is the director of research for the
Economic Cycle Research Institute , which was founded by Dr. Geoffrey H. Moore, creator of the original index of leading economic indicators (LEI) for the U.S. Department of Commerce. Banerji is on the economic advisory panel for New York City, and is also a member of the OECD Expert Group on Leading Indicators. At time of publication, neither Banerji nor his firm held positions 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. While Banerji cannot provide investment advice or recommendations, he welcomes your feedback at