Is the Labor Recovery For Real or Will A Crash Occur?

 

What’s the best answer to the labor market puzzle? Economists are divided between those who believe in the theory that there is a lot of hidden long term unemployment versus those who feel the current official unemployment rate of 6.3% (which will be 5.0% in a year) is accurate.

The qualitative nature of the job market shows a lesser number of middle-skilled jobs after the crash.  If the Labor Force Participation Rate had not dropped 3% since the crash of 2009 then unemployment would be about 9.5%, almost as high as the peak in 2009. It is now 6.3%. One can try to imagine lots of people suddenly decided to take early retirement. If so they would have gained confidence to do so during a stock market bubble and not during a crash, so it is unlikely that people voluntarily took early retirement.

The labor market last week recovered all lost jobs since the top in 2007 but after adjusting for population increases of 0.5% a year we need another 3.5% more jobs just to equal the old labor high of 2007. Interesting “coincidence” how that 3% gap is roughly equal to the 3% of labor force dropouts!

An analogy with the employment gap of missing jobs needed by new workers is the GNP “opportunity cost” gap. In normal times nominal GNP used to grow at 6% or 4%. During the crash the GNP didn’t exceed the old 2007 high until June, 2013 in real terms. If it had grown at its traditional pace then it would be about 15% or 25% higher. This matters to indebted people because as the economy grows then debtors with affordable debt loads can grow their way out of debt and renters can grow their savings for a down payment on a house. However, in a stagnant economy people can’t grow their assets and income to meet these objectives and thus will fall further behind goals such as savings for their kid’s college or saving for retirement. At some point they will be too old to work and will have to accept a substandard retirement or engage in high risk investments, etc., neither of which will result in a better off consumer. Thus future demand for goods will be repressed because of the stagnant economy.

In the area of investing, databases can show misleading statistics such as “survivorship bias” where failing mutual funds are closed and only winners and breakeven funds are allowed to continue, thus boosting the reported average rate of return. By analogy the same thing can and did happen in the job market where some job hunters simply gave up during the crash of 2009 and their absence has created a survivorship bias in the measurement of unemployment.

The declining Labor Force Participation Rate has been attributed to men staying home to raise children while the wife works. But why did such an alleged trend just happen to start during the crash of 2009 when consumers and investors were worried about money that would not be the time to quit work and become a stay at home parent.

It is a luxury to drop out of the workforce for an early retirement. A luxury like that can be financed by a lucrative stock market or lucrative Civil Servant Defined Benefit pension. Except for a few urban states civil service pensions are not that lucrative. Studies show that the bottom 80% of the population didn’t have much invested in stocks and suffered a pay cut in real terms, so these people are unlikely to suddenly take voluntary early retirement during a scary stock market crash of 2009.

The problem with finance professionals is that the more prominent ones who get the most news interviews are very affluent and only associate with other highly affluent people so they don’t recognize the economic weakness suffered by the moderate income middle-skilled people.

Since 1998 there has been no increase in total hours per year worked by all workers and no “real” inflation-adjusted pay increase. Assuming that real GNP used to grow at 2.1% a year then shouldn’t workers have managed to grow their real income in proportion, which means they have suffered an opportunity cost of roughly 15% below projected income since 1998. This opportunity cost translates into a need to cancel other hoped for goals, further reducing economic growth.

The sharp drop in new home purchases now down to depression levels of 400,000 a year from the old high of 1.4 million (the long term average is about 800,000) is a sign that when people are hurt by the economy they react by cutting home purchases and instead rent a smaller residence.

The bullish people would say that because stocks are at new highs that the economy is doing better. Unfortunately stock and real estate prices can be an emotional misrepresentation of true economic value (aka a bubble fueled by low interest rates). What are more reliable than asset prices are things like “real” GNP, corporate “real” sales, and “real” personal earned income. None of these have done well since the 2007 top, especially if one subtracts out the top 10 or 20% of society.

The reason economists have trouble understanding this recession is because it is fundamentally different than typical recessions. What is different is that there is an unprecedented amount of debt worldwide which acts to suppress global demand and there is an unprecedented era of rapid technological change which makes it harder for the bottom 80% of workers to quickly relearn new job skills. The old economic patterns are less relevant during the current recovery. The best estimate is that the economy hasn’t fully recovered from the 2007 crash after adjusting for inflation and population. A good article about output gap is by Gavyn Davies in the FT.com “Can the Great Recession Ever be Repaired?”

If the economy hasn’t recovered from the 2008-09 crash then stock prices should be somewhat closer to the lows of 2009 instead of experiencing a massive run-up in 2013. I believe stocks are bubble that went up because of affluent people engaging in short term speculative trading rather than because stocks reflect actual economic growth.

Investors need independent financial advice about the risks of stock market bubbles and crashes. I wrote an article “Economy improved but not enough to justify high stock prices”.

 

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About the author

Don Martin, CFP®

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