Saturday, June 4, 2011

The jobless recovery analysed

Nowadays, the term "jobless recovery" is thrown around quite often. What it means is that the economy recovers in theory, with GDP growing, but there are no jobs created.

Here in this post, I am going to answer two questions:
1) Why does a jobless recovery happen?
2) Can a jobless recovery keep going forever, or will the economy at some point start to add jobs (or, will another recession being if jobs aren't created despite the economy booming)?

Let's start with the first one.

Basically, hiring someone is a long-term decision. Unless you are hiring strictly temporary workers that is, but then that has several disadvantages and isn't a possibility for some firms. When you hire, you have to be sure that you will need the additional employee not just for now, but in the future as well.

Therefore, even if a company can afford another employee today, they won't hire one because they feel that the future of the economy is too uncertain.

Why is it uncertain? If government spending is the main factor driving the economy, and the level of government spending is unsustainable, then that means the economy is... unsustainable.

That is not to say a high level of government spending is by default unsustainable (the economy can, to some extent, "get used" to high government spending), it only means that running a deficit isn't sustainable, and that the private sector knows this. Growth which depends on deficit spending cannot be sustained forever.

On the other hand, stock markets can still boom even while no-one is hiring. Because, with companies having a lot of profits (temporary but still) but nothing they dare to invest in (because the future is so uncertain), that leaves a lot of money which is given out in dividends. And since the stock price depends on dividends, that means increased stock prices. Of course, dividend policy must also be long-term, and companies in general don't want to suddenly increase or decrease their dividend because they don't want to cause shocks to their stock price. The way to go is through smooth changes. If a company suddenly pays out a huge dividend, this doesn't necessarily please investors because they will think that the company cannot keep paying out that dividend forever, and since the stock price is the sum of all future dividends (discounted, but let's not make it too complicated), one big dividend won't change it very much. It may even make investors suspicious; why would a company raise its dividend so much, are the managers trying to cover up that the firm is in serious trouble?

The fact that the stock market has more or less recovered from the big drop in 2007/08 shows that they think the dividends will increase permanently. This is actually bad news for the american economy: It means that investors suspect companies are going to continue to spend their profits on dividends rather than hiring for a long time. And they may be right.

Now, let's get onto the second question: Can this continue forever?

The short answer is No.

The reasons are many. The most obvious one is that the non-job producing growth is, as I said earlier, driven by unsustainable government spending. When this unsustainable spending ends (and it will, one way or the other, sooner or later), then the economy will almost certainly experience a new recession. After a while though, interest rates will have fallen back and there will be more money left for the private sector to borrow, now that the government isn't borrowing anymore. This leads to a spike in investment and in employment, since these new, lower rates are for real. This growth is sustainable, because the lower interest rates are created by the market and reflects a new reality where the government is no longer crowding out private investment and raising interest rates.

However, the long answer is more complicated. In a practical, America-specific context, we need to consider outsourcing. See, the exchange rates affect the competitiveness of American products abroad. If the dollar is strong, that means prices of American goods will be high in terms of foreign currency, and so exports decrease.

The exchange rate depends a lot on the interest rates within America, and in particular the central bank interest rate. If the central bank raises the interest rate, that means fewer dollars will be printed, and the dollar becomes stronger (demand for dollar stays the same, but supply goes down). This means fewer exports, a higher trade deficit, american companies (in particular manufacturers) going out of business or being outsourced.

So what's the problem? Just don't raise the interest rate then, and we'll all be fine... right? Not really. The FED interest rate is at an all time low right now, and keeping it there will cause massive inflation in the future (as a matter of fact, I'd argue they should have raised it long time ago). America is running a trade deficit despite these low rates, and it will only get worst as the FED is forced to raise interest rates. This may lead to unemployment actually going up, or not decreasing, in areas where manufacturing industries are still employing a significant proportion of the workforce (poor Michigan...).

Companies paying out too high dividends is a problem not only for them (it will be hard for them to keep paying out those high dividends in the future), but for the economy as a whole: Long-term economic growth depends on technological development, and technological development depends largely on how much money is invested in Research and Development (R&D). That makes sense, - the more research you do, the more discoveries you get. And the more money is paid out to investors in the form of dividends, the less money the firm will have that it can plow back into the company and invest in R&D. With less R&D, long-run growth falls, leading to even higher unemployment in the future.

I hope you have been able to follow this post, and that you understand what I'm trying to say. I realize the subject gets a bit heavy sometimes, but it's important to understand so please do your best to. Thanks for reading,

/John G


BOSMAN said...

Hi John,

"Basically, hiring someone is a long-term decision. Unless you are hiring strictly temporary workers that is, but then that has several disadvantages and isn't a possibility for some firms. When you hire, you have to be sure that you will need the additional employee not just for now, but in the future as well."

Now you're sounding like Mitt Romney. That line I quoted sounds a lot like something out of one of Romney's op-eds

Revolution 2012 said...

I have a feeling that John may be leaning towards Mitt Romney.

GetReal said...

I don't think John is ever going to be a Romney supporter, but it does sound a bit like a Romney op-ed.

John is also right on the money with this piece.