December 6, 2010

Welcome to the New (Ok, Actually Kinda Old)

Job Market!!?
Last week ended with payroll Friday—a monthly Wall Street ritual whereby players watch in
rabid anticipation for the 8:30am EST official government estimate of the number of jobs created
or lost in the U.S. economy. Supposedly this monthly release helps clarify the condition of the
economy. More often, though, it tends to leave investors perplexed, frequently accentuating
financial market volatility and thereby seeming more useful to traders than investors.

Last Friday’s report was no exception. The numbers were simply “bad” suggesting the job
market had weakened considerably in November. A head scratcher though, since Friday’s job
report is at odds with nearly every other economic report (most suggesting the economic
recovery and job conditions have been improving) of the last couple months. Hmmmm? Once
again, rather than promoting clarity on the job market, Friday’s payroll report produced a day of
trendless stock market volatility (down in the morning after the jobs report only to end slightly
higher on the day) and left puzzled investors to ponder whether these new numbers are
significant or will simply be revised away in future months.

While investors can get pretty lost inside the minutia of a monthly job report, a longer term
assessment of the job market is important. Many are concerned about how slowly the
contemporary job market is reviving. In earlier post-war times, job market recoveries tended to
be quick and robust once the recession ended. By contrast, monthly job gains so far in this
recovery remain less than required to lower the unemployment rate. Consequently, many
investors, leaders, and policy officials believe the economic recovery is simply not emerging
adequately and additional economic stimulus is needed.

While the operation and character of the U.S. job market does differ from earlier post-war times,
its recovery path actually appears quite “normal” compared to recoveries of the last 25 years.
Like today, the last two recoveries were slow at the start and did not initially produced jobs.
However, as the current job market will likely resemble, both the 1991 and 2001 recoveries
eventually geared and ultimately produced decent job gains.

Welcome to the “new” job market! Well, if new can be 25 years old? What is the character of the
new job market and why has it changed from earlier in the post-war era? Most importantly, is the
contemporary job market recovery working and will it ultimately prove adequate?

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Exhibit 1: New Economic Speed Limit
U.S. Total Civilian Labor Force
Shown on a natural log scale.

Annual Real GDP Growth

2
 U.S. Economic Speed Limit Lowered in 1985

The nature of the economic and job market recoveries was primarily altered by a watershed
downshift in the growth of the U.S. labor force commencing in the mid-1980s. This secular
slowing in the U.S. labor force has lowered the speed limit of economic growth to only about 4
percent. Exhibit 1 compares a chart of the U.S. labor force with the annual rate of real GDP
growth since the early 1960s. Prior to 1985, the U.S. labor force was boosted by a baby boom
maturation and by women entering the labor market. The positive impact of these trends waned
however in the last 25 years forever lowering the inherent speed of achievable economic growth.
As illustrated in this exhibit, in the 25 years leading up to 1985, annual real GDP growth
exceeded 4 percent more than one half the time, whereas since, it has surpassed a 4 percent
annual growth rate only about one-quarter of the time. Moreover, prior to 1985, the annual “year-
on-year” growth has often reached levels between 5 to 8 percent; while since 1985, it has
exceeded 5 percent in only two out of 102 quarters!

So, similar to the other recoveries in the last 25 years (1991 and 2001), although job creation in
the contemporary recovery is not as robust as earlier post-war recoveries, this does not imply the
current recovery is a failure, that it is not sustainable or that economic policies are not working.
Rather, like the last two recoveries, it simply shows the impact of the “slower labor-force
induced speed limit” imposed on the economy since 1985. When compared to the character of
the last two recoveries (those which have taken place since the labor force slowed), the current
economic recovery including the job market appears quite “normal” and gives every impression
of following a similar path to the 1991 and 2001 recoveries.

A New Business Culture Has Delayed Job Recoveries

The “new” job market of the last 25 years has also been shaped by the emergence of a new
business culture—one increasingly focused on productivity, cost-cutting, and efficiencies—
which has delayed job market recoveries compared to earlier decades. As illustrated in Exhibit 2,
in the quarter-century leading up to 1985, corporate CEOs learned prices always went up! Given
a chronic ability to pass on any cost increases, there was little need for companies to focus below
the top-line. If wages went up, if interest rates rose, and, if they had a three martini lunch, they
could simply raise prices after lunch. This was an era where sales always rose and prices could
always be increased. Why worry about over-staffing, over-inventorying, or over-spending when
the business could always be bailed out by growth and price hikes.

This business mindset reinforced by years of persistent inflationary conditions caused the job
market to respond quickly and robustly during economic recoveries. The CEO mindset of the
day was one which was more concerned about losing potential sales share to competitors (and
thus most were quick to hire and expand operations again at the first sign of economic recovery)
than it was worried about over expanding too fast and having again to contract (after all it could
always raise selling prices).

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 Exhibit 2
U.S. Five-Year Average Annualized Inflation Rate*
*GDP Price Deflator Inflation Index

A major change in top-line pricing conditions occurred in the mid-1980s. For the next 25 years,
price inflation would slowly decelerate, price competition would steadily intensify, and a new
corporate culture was born. Without the ability any longer to pass on cost increases, the CEO
mindset quickly turned to activities below the top-line—rightsizings, mothballings, cost-cutting,
efficiencies, scale-economies, and tech-induced productivity gains became all the rage.

Exhibit 3 provides an illustration of the impact this newfound corporate culture has had on the
job market. It overlays the productivity index with the level of non-farm private payroll
employment. In each of the last two economic recoveries (1991 and 2001), job creation was
initially a “no show” early in each recovery until productivity growth slowed. Although the
early-1990s recession ended in March 1991, it was not until the beginning of 1993 (once
productivity growth waned) that job creation finally accelerated. Similarly, the early 2000s
recession ended in November 2001, but job creation was absent until the latter part of 2003 when
productivity growth finally slowed.

The contemporary job recovery has been similar to the 1991 and 2001 recoveries. The
productivity surged in the early part of this recovery has held back job creation even though real
GDP growth has been 3.2 percent in the last year. Given the severity of the last recession and
after 25 years of persistently intensifying price competition, CEOs are mostly focused on
“rightsizing” operations. Productivity has always played an important role in recoveries by
helping to restart the profit cycle, replenish business cash flows, and improve company balance
sheets. However, in the last several recoveries (since the mid-1980s), it has also tended to be a
job destroyer and job market recovery delayer in the early part of recoveries.

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 Exhibit 3
Productivity and Job Recoveries Since 1985

Delayed but Not Dead Job Market

A productivity-obsessed CEO culture during the last quarter-century has delayed job market
recoveries, but it has not stopped them. As shown in Exhibit 3, eventually businesses run into the
physical limits of productivity enhancements. They simply cannot keep growing productivity at
rapid rates and once productivity growth slows, job creation emerges. As it did in both the 1991
and 2001 recoveries, it appears as though this same pattern is being followed today. Productivity
growth has finally showed signs of slowing since the summer and most reports suggest the job
market is coming to life.

Exhibit 4 demonstrates more clearly how the job market has changed in the last 25 years. This
chart shows the level of non-farm payroll employment during expansions and recessions. During
the 1970, 1975, 1980, and 1982 recoveries, job creation surged as soon as the recession ended.
However, in the 1991, 2001, and contemporary recoveries, the job market simply did not respond
initially to the overall economic recovery.

Exhibit 5 shows this newfound character of the job market is also reflected by the pattern of
consumer confidence. Prior to the 1991 recovery, the Consumer Confidence Index recovered
quickly and robustly as soon as the recession ended. However, since a productivity-focused CEO
has delayed the job market recovery, confidence has also been slow to recover.

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 Exhibit 4
Non-Farm Private Payrolls* and Recoveries
*Non-Farm Private Payrolls. Shown on a natural log scale.
Shaded areas represent recessions.
11.7

11.6

11.5

11.4

11.3

11.2

11.1

11

10.9

10.8
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Exhibit 5
Consumer Confidence Index* and Recoveries
*Conference Boards Consumer Confidence Index. Shown on a natural log scale.
Shaded areas represent recessions.

4.8

4.4

3.6

3.2
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

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 Back-End Loaded Economic Recoveries

Exhibits 4 and 5 suggest U.S. economic recoveries have become “back-end” loaded in the last 25
years. A cost-conscious business focus initially delays job gains, which keeps consumer
confidence and spending trends depressed longer. However, once productivity growth slows, job
creation, confidence, and consumer spending have responded and ultimately produce a decent
economic recovery. Whereas the strongest growth rates in earlier post-war recoveries were
typically in the first year of economic expansions, the strongest growth rates in recent recoveries
have come later in the expansion.

Consequently, for U.S. leaders, policy officials, and investors to focus on these earlier recoveries
(those which occurred with faster labor force growth and with a much different CEO culture) as
reference points in judging the contemporary recovery is improper. Such comparisons will
continue to lead to overstated fears and inappropriate economic and investment judgments. For
example, these beliefs have already fostered views the recovery is not sustainable, that economic
policies have not worked and that more policy accommodation is required.

So, welcome to the new job market—or the old job market of the last 25 years. It may not get off
the starting line as fast as it did decades ago, but it has proved a good finisher. In the meantime,
the contemporary job market recovery appears quite “normal.” Indeed, as shown in Exhibit 6, it
has been quicker to return to positive job creation and has thus far produced more job gains
compared to either the 1991 or 2001 recoveries!

Exhibit 6
Job Market Recoveries Since 1985
Current Recovery vs. 1991 and 2001 Recoveries*
*Non-Farm Private Payroll Employment Indexed at 1.0
1.005
at the Trough of Each Recession.
Employment Level as a Ratio of Employment at Recession

Current 2009
Recovery

1991
Trough

0.995 Recovery

0.99
2001
Recovery

0.985
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Number of Months Since Recession Ended

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 A Final Thought on the Unemployment Rate

The unemployment rate hovers about 10 percent today as it did in the early-1980s. Even with
expected improved job market trends in the coming year, as productivity wanes and companies
are forced to increase staffs, the unemployment rate will likely remain high for many years. This
is unfortunate, but certainly not unprecedented.

Exhibit 7 overlays the current unemployment rate with the unemployment rate during the 1980s
recovery. It is interesting to note that even though at this point of the recovery (i.e., 17 months
in) in 1983 the unemployment rate was lower than it is today, the rate of unemployment was still
above 7 percent almost three years later! That is, the unemployment rate was still almost 7
percent at the start of 1987. By all accounts the 1980s recovery was a solid economic period and
yet it was characterized throughout by an extremely high unemployment rate. The current
recovery looks similar. Simply because the unemployment rate may remain high for years, this
does not imply the “recovery” will be weak or poor.

Exhibit 7
Unemployment Rate—2010 vs. 1982
Current Recovery—Solid
1982 Recovery—Dotted
11

10

4
2009 2010 2011 2012 2013 2014 2015 2016

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The labor force is likely to grow by about 1 percent annually in this recovery (its average during
the last 25 years). This implies monthly job creation will need to be about 125,000 just to keep
the unemployment rate from rising. Year to date in 2010, the U.S. economy has created about
106,000 payroll jobs a month. Since productivity growth is now finally slowing, we expect the
pattern of job creation to be similar to the 1991 and 2001 recoveries and therefore anticipate
private monthly job creation to expand to about 225,000 in 2011. This rate of job creation would
be sufficient to trim about 1 percent off the unemployment rate annually. If this pace were
maintained for the next three years, the unemployment rate in this country would decline to
about 7 percent by late 2014 which is almost exactly the same degree of improvement in the
unemployment rate which took place during the1980s recovery. The high unemployment rate is
certainly a difficult economic, cultural, and political phenomena, but the U.S. has been here
before and ultimately economic conditions proved far better than feared.

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