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The missing ingredient in the economic expansion - new jobs.

THE SLOW GROWTH of job opportunities in the current economic expansion, at least until mid-1992, has been a major source of concern to all levels of government, the public in general, and is a particularly disappointing aspect of the business turnaround. Consumers are still concerned over the viability of their jobs and their generally poor prospects for finding other employment. These concerns are reflected in a low confidence rating and a cautious approach to consumer spending. The initial phase of the economic recovery has been supported by pent-up consumer demand and business' need to replace existing equipment. A sustained expansion, however, requires new sources of consumer income and corporate earnings that can only come from new job creation. Because job growth will ultimately determine the viability of the economic expansion, it is important to understand why relatively few net new employment opportunities have been generated since the end of the recent recession.

A JOBLESS RECOVERY

The 1990-91 economic recession ended in March 1991 but little job growth has occurred in the past two years. Figure 1 shows the cumulative percentage change in U.S. nonfarm employment during the current recovery (April 1991 through March 1993) and average employment growth in business recoveries following the 1970, 1974-75, and 1981-82 recessions. During the first twelve months of the current economic recovery (April 1991 to March 1992), employment did not grow at all. Even twenty-four months after the trough of the 1990-91 recession, nonfarm employment increased only 0.8 percent. In contrast, during the previous three recovery periods, employment increased 2.9 percent in the first year and a cumulative 7.0 percent in the first twenty-four months of recovery.

Clearly, the current business rebound has not generated sufficient jobs; the unemployment rate continues to hover around 7 percent. Since March 1991, nonfarm employment rose by only 866,000 and virtually all of this job growth has occurred in the past eight months. In contrast, nonfarm employment increased by an average of 5.6 million in the first twenty-four months of each of the previous three business recoveries and these job gains occurred progressively over the period.

There also are major differences in the industrial makeup of the employment gains in this recovery versus a "normal" one. Figure 2 lists the major business sectors in the United States and shows the average change in employment in the first twenty-four months of recovery during the three previous business cycles compared with the current rebound. Some important differences between the business recovery that began in 1991 and other business cycles are listed below:

1. Manufacturing and retail trade provided over 1.2 million jobs each in the twenty-four months after the trough of the three previous recoveries. From March 1991 to March 1993, manufacturing employment declined by 387,000 and retail trade employment was virtually flat.

2. In a normal recovery, the construction, wholesale trade, and finance, insurance and real estate sectors provide several hundred thousand jobs each. In the current period, all these sectors experienced declining employment.

3. Although 479,000 new business service sector jobs were created in the current recovery, this number is somewhat deceiving. Temporary workers, which enable employers to avoid hiring new permanent workers, were responsible for almost all of the growth in business services employment.

4. Health services and state and local governments created new jobs in the past twenty-four months. Health service payrolls grew by 550,000 and state and local government jobs expanded 370,000 in this period.

The restructuring and downsizing taking place in many sectors, particularly the defense-related industries, contributed to a rising unemployment rate for the first fifteen months following the end of the 1990-91 recession. At the recession's end, March 1991, the unemployment rate was 6.6 percent. The unemployment rate actually continued to rise as the economic recovery progressed, until it reached a peak of 7.6 percent of the civilian labor force in June 1992. Faster economic growth in the second half of 1992 brought a steady decline in the unemployment rate to the latest figure of 7.0 percent in March 1993.

REASONS FOR LACKLUSTER EMPLOYMENT GROWTH

Two explanations are frequently given for the slow growth in employment during the current business recovery. One is that the pace of economic growth has been so sluggish that firms (particularly small-and medium-size firms) were reluctant to add more workers. Companies extended overtime hours to their existing staffs while waiting for evidence that the recovery is sustainable before adding more workers to handle the increase in business activity. Another reason is that a fundamental change may have occurred in the service sector that in turn raised the growth rate of productivity. Proponents of this theory cite the large increase in nonmanufacturing productivity in 1992 as evidence.

Sluggish Economic Growth

Growth in the real value of the nation's production of goods and services has been below the average of the three previous economic recoveries since the current turnaround began in the second quarter of 1991. Figure 3 shows the cumulative growth in inflation-adjusted gross domestic product (GDP) over the first seven quarters of the economic recovery and compares it with the average recovery from the 1970, 1974-75, and 1981-82 recessions. Real GDP increased a cumulative 4 percent in the current recovery. In the three prior recovery periods, it increased a much larger 9.2 percent. The 5.2 percentage point difference between economic growth in this economic recovery and the average of the prior three is equivalent to more than one year of lost economic output.

A number of economic imbalances and structural changes explain why real GDP growth has been slower in the current business recovery than in previous periods. Some of these factors are listed below:

1. Actual defense cuts and prospects for additional sharp reductions are forcing defense-related business to downsize.

2. The inability to raise prices has led firms to restructure costs in order to maintain their profit margins. Restructuring displaced many formerly secure "white collar" workers and contributed to the "lack of confidence" in the economy.

3. State and local governments are raising taxes on individuals and business, thereby simultaneously reducing consumer income available for spending and lowering business cash flow.

4. Firms changed the way they managed their inventories in this business cycle. In this recovery, just-in-time inventory techniques limited the amount of inventory rebuilding that typically occurs in the early stages of an economic recovery. Inventory buildup is now increasing, but only enough to meet current production and not to cover anticipated future sales. In the past, anticipatory inventory rebuilding usually accounted for a large portion of output growth in the early phase of a recovery.

5. Severe overbuilding prior to 1991 in commercial office buildings, shopping centers, and hotels continues to depress the private nonresidential construction market.

6. A glut of residential apartment buildings and fewer people in the 25- to 34 prime home-buying age limits the rebound in the housing market.

7. Consumers and business are devoting a larger portion of their incomes to pare down debt accumulated during the late 1980s.

8. A large spread exists between long-term interest rates and inflation. High real long-term interest rates deter investment spending.

9. Slow growth of our trading partners, particularly the United Kingdom, Germany, and Japan, have limited the growth in U.S. exports.

Labor Productivity Growth

Nonfarm business productivity is calculated by dividing labor man-hours into gross domestic product of the sector. Using this calculation, the difference between the growth in real GDP and employment is approximately equal to labor productivity. Therefore, one would expect a large increase in labor productivity in the first seven quarters of the economic recovery because GDP has been growing, while employment was virtually flat.

Because labor productivity is calculated by estimating output and man-hours worked, it contains errors in measurement of these two series and reflects cyclical as well as secular forces. When demand rebounds business can boost productivity in the short term without hiring new workers, but unless the rate of innovation accelerates, productivity growth will eventually return to its lower long-term trend. For example, productivity grew at a 3.3 percent annual rate in the first seven quarters of recovery from the 1970 recession and at a 2.9 percent annual rate in the first seven quarters following the 1974-75 recession, although the growth rate for the decade of the 1970s was only 1.3 percent annually. Similarly, nonfarm business productivity expanded at a 1.9 percent annual rate in the first seven quarters after the 1981-82 recession, but grew only at a 0.8 percent annual rate in the 1980s.(1)

Figure 4 illustrates that labor productivity in the nonfarm business sector always seems to grow rapidly after a recession. In the first seven quarters following the end of the 1990-91 recession, nonfarm labor productivity grew at a 2.6 percent annual rate. This growth rate is well above the 1.9 percent rate achieved after the 1981-82 recession, but less than the two recoveries prior to the 1981-82 recession.

Some analysts believe that investment in computers is finally paying off in the service sector of the economy through faster productivity growth. Many firms invested heavily in computers, but then failed to trim staffs and did not realize the benefit of the investment. According to Stephen Roach, an economist at Morgan Stanley, the amount of technology per worker in the service industries doubled in real terms during the 1980s. The ratio of clerical and administrative workers to managers and professional staff, however, remained about the same.(2) Roach's thesis is that the 1990-91 recession brought about major restructuring in many service industries, forcing managers to finally pare their employment rolls.

Other analysts believe that the change in relative prices between labor and equipment has discouraged firms from hiring workers in favor of purchasing productivity-enhancing machinery. The rapid increases in the costs of fringe benefits, in employment taxes, and government regulation have raised the cost of labor at a much faster rate over the past several years relative to the cost of equipment. Under this thesis, productivity growth will accelerate along with rising investment spending.

While the impact of the rapidly growing investment in computers and other equipment on productivity should not be understated, it is still too early to predict that the nation's long-term productivity growth rate will increase substantially. Typically, productivity improves rapidly in the early phase of an economic expansion but declines to a much lower long-run rate as the expansion continues. For example, in the first seven quarters following the 1981-82 recession, productivity growth outside the manufacturing sector grew at a 1.6 percent annual rate but expanded on average only 0.2 percent per year during the entire 1980s. In the first seven quarters after the 1990-91 recession, nonmanufacturing productivity increased 2.3 percent but the rate of increase is likely to decline as the economic expansion continues.

STRUCTURAL LABOR MARKET CHANGES

In this current recovery, structural changes are responsible for the relatively slow economic growth. One symptom of these changes is the high proportion of job losses that are permanent. As shown in Figure 5, the ratio of permanent job losses to total unemployment varies with the business cycle. In the initial stage of a recession, layoffs increase substantially and the proportion of permanent job losses among those unemployed declines, typically to about 62 percent. During the subsequent economic upswing, unemployment declines and a higher proportion of the job losses becomes permanent.

The composition of layoffs during the recent recession and economic recovery has followed a pattern different from previous business cycles. As can be seen in Figure 5, the decline in the permanent job loss ratio during this past recession was nowhere near as deep as in previous recessions, while the 76.5 percent of workers who lost their jobs permanently in 1992 was the highest percentage on record. This suggests that labor markets have been affected by significant structural changes during the current business cycle.

One major structural disruption affecting the job loss ratio is the shrinking defense industry. While cuts in federal defense appropriations began in 1987, aggressive downsizing has taken place only in the past few years. Figure 6 shows employment in industries where at least 50 percent of the products are manufactured for defense purposes. As shown in the chart, defense-related employment peaked in October 1986 and drifted down slowly until June 1990. After June 1990, the number of defense-related jobs dropped sharply each month. From June 1990 through March 1993, defense-related employment in these selected industries declined from 1.415 million to 1.095 million, a 23 percent reduction.

Another structural change is the globalization of U.S. business. The volume of trade in manufactured goods is expanding, and more U.S. firms are participating in international competition. In 1980, inflation-adjusted exports plus imports as a percent of GDP was 16 percent; by 1990, trade as a percent of the U.S. economy was 22 percent. In the past two years alone, however, the trade ratio has increased to 24 percent. The heightened business competition from foreign trade contributed to a growing number of permanent job losses and a record number of displaced workers among the unemployed.

Many of the workers who have lost their jobs permanently found that obtaining new ones is difficult because their skills are not easily transferable to other occupations and industries. This increase in structural unemployment affects an important segment of the labor force, and for this reason the government initiated a series of five biannual surveys of displaced workers starting in January 1984. For the surveys, the U.S. Department of Labor defines "displaced workers" as individuals age 20 years and older who have been with their employers for at least three years and lost their jobs in the last five years because the employers' plant or business closed or moved, their positions or shifts were abolished, or there was not enough work available for them.(3)

The average number of displaced workers as reported in each of the five government surveys appear in Figure 7. It is clear that 1992 was an extraordinary year in terms of the number of displaced workers. There were 5.584 million displaced workers in the five-year period ending January 1992 -- an average of 1.117 million a year. The next largest number of displaced workers was in the January 1986 survey, which included the 1981-82 recession. According to the 1986 survey, an average 1.026 million workers a year were displaced during the previous five-year period.

Another displaced worker survey finding is that there have been significant changes in the industrial makeup of displaced workers in the past decade. The most dramatic and visible sign of change is that a larger portion of displaced workers are now from the service-producing sectors. A few possible reasons for this structural change in labor demand are listed below:

1. Some segments of the service sector are being exposed to foreign competition. For example, foreign-owned banks are expanding operations in the United States and debt placement, foreign exchange, and capital markets are all global in nature.

2. The transportation and communication sectors are increasingly exposed to more competition as the result of government deregulation.

3. Public utilities are experiencing difficulty in obtaining the approval of utility commissions to raise rates, thus being forced to reduce costs to maintain profit margins.

4. A surge in foreign direct investment has occurred in the service industries. These foreign owners are pressuring their domestic managers to demonstrate strong financial performance.(4)

CONCLUSION

The extremely slow job growth during the current economic expansion can be traced to a number of structural changes that have occurred in the business environment. Economic growth is sluggish because the economic imbalances and structural changes are being slowly corrected. Consequently, jobs are not expanding rapidly due to the cautious approach taken by employers in adding workers until there is more evidence that the business upturn will last.

There is a wide range of views on the prospect for employment expansion for 1993 and beyond. The rapid downsizing in defense and the cost-reduction programs to improve efficiency throughout manufacturing and nonmanufacturing have led many to assume that there has been a fundamental change in the number of workers required to produce a given output using the same amount of plant and equipment. It is argued that the work force will have great difficulty adjusting to this dramatic shift in the capital/labor relationship that produced an upsurge in productivity. Proponents of this view believe that productivity will continue improving at a higher rate, leading to further layoffs and, as a result, job growth in the 1990s will be very slow.

This report explains that there is nothing unusual about the increase in productivity following the recent recession. Indeed, it will be difficult to maintain the current rate of productivity improvement as the economy continues to expand. While it may take time before the labor markets adjust to recent structural changes, the key to employment expansion is increasing the rate of economic growth. Provided the government adopts an effective long-run growth strategy, based on increased saving and investment, there is no risk that job growth will stagnate.

It is important for policy makers not to fall into the trap of associating rapid increases in productivity with slow employment growth. In fact, just the opposite is true. In the decade of the 1960s, strong gains in labor productivity led to rapid economic growth and robust labor markets. Productivity is, after all, the basis of a rising standard of living. Increased labor productivity means workers can produce more output with the same amount of effort. Faster productivity growth also lowers costs and makes U.S. products and services more competitive in overseas markets.

Future job growth also depends on economic growth. Employment opportunities will accelerate well into the 1990s, provided public policies create an economic environment that encourages investment in new plant and equipment. The combination of rapid productivity improvement and an increase in the amount of capital and labor devoted to production is the source of economic growth. What this means for the 1990s is that, if government policies promote capital investment and the financial incentives are in place, then strong economic growth, low unemployment, and a rising standard of living for all Americans can occur simultaneously.

FOOTNOTES

1 Historical data provided by the U.S. Department of Labor, Bureau of Labor Statistics, Productivity and Costs, Washington, DC, February 4, 1993.

2 "America the Super-Fit," The Economist, February 13, 1993, p. 67.

3 The displaced worker surveys and the government programs to help displaced workers are the subject of a MAPI Policy Review PR-122, Finding Another Job in a Time of Industrial Restructuring, February 1993.

4 "America the Super-Fit", op cit.

Daniel J. Meckstroth is an economist with the Manufacturer's Alliance for Productivity and Innovation (MAPI) in Washington, DC. The author is indebted to Diane Threlkeld and Donna Windsor for their editorial assistance. This study first appeared as a MAPI Economic Review, ER-260, March 1993.
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Author:Meckstroth, Daniel J.
Publication:Business Economics
Date:Jul 1, 1993
Words:3176
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