Slow Job Growth – Get Used To It
May 9th, 2016
There is a new paradigm for developed market growth, and it is grounded in changing demographics. Currently, there is a pervasive misconception among mainstream media that the US economy needs to be growing at a real rate of 3% to be healthy. There is also a belief that 150,000 additional jobs per month demarcates weak and robust non-farm payroll growth – a Maginot Line defending the U.S. economy from economic contraction. These statistics are the relic of a past economy, one whose working age population was growing at almost 1.5% per year.
The employment report on Friday was mixed in terms of its implications for the broad economy. The headline number of 160,000 additional jobs added in the month of April missed analyst expectations of 200,000 adding fuel to the notion that the Federal Reserve will not raise rates in June, and is potentially on hold for the remainder of the year. On the other hand, the unemployment rate remained steady at 5.0%, average weekly hours worked ticked up to 34.5, and average hourly earnings increased .3% and are now up 2.5% year-over-year. In terms of the Fed, they will focus more on wage growth moving forward than on headline job growth, and for good reason. As evidenced by the chart below, this has always been the focus of the Federal Reserve. When wage growth accelerates, they tighten monetary policy to curtail future inflation, and vice-versa. The market should focus on wage growth as the primary indicator to gauge potential Fed action. From this standpoint, the knee-jerk reaction of lower treasury yields on Friday was an overreaction. Indeed, they reversed much (if not all) of their gains across the curve. Still, the market is considerably underestimating what the Federal Reserve could do over the next 12 months given that wage growth looks to be gaining steam.
It is perplexing that markets continue to consider anything under 150,000 jobs as a weak number. Analysts need to change their expectations for what is, and what is not, a robust jobs report. Consider this: from 1955 to 2007, the working age population in the United States grew an average of 1.4% annually. Since 2008, it has only grown .5%.
Given the current labor force of 159 million, this means that monthly increases (holding the participation rate constant) of 66,000 are all that are needed to maintain a constant unemployment rate. Moreover, as the economy approaches full employment, it is reasonable to expect that the pace of employment gains will diminish. The data is already bearing this out. Average monthly gains have gone from 250k two years ago, to 190k more recently. This is not unhealthy, only natural.
Demographic changes in the United States are what they are. People are living longer, and they are having less children. As a result, future growth will be curtailed. However, this is not necessarily a pernicious development. Standard of living is measured by GDP per capita, and slowing population growth subtracts equally from both its numerator and denominator—they cancel out. From 1955 through 2007, GDP per capita growth averaged approximately 2.2%. Since 2008, it has averaged a meager .4%, and is currently at 1.2%. This is a problem for the U.S. economy. Historically, the standard of living doubled every 33 years. At the current pace, it would take 60 years. This shortfall is a function of slow productivity growth, and not changing demographics.
Gross Domestic Product is, by definition, the value all of the goods and services produced within a country. As a corollary, GDP growth can be deconstructed as the growth in total hours worked in an economy multiplied by productivity growth (the increase in output per hour worked). Accordingly, increases in GDP can be attributed to the following factors:
1) Increases in the working age population
2) Increases in the participation rate
3) Increases in the average work week of those employed
4) Increases in productivity (the amount of goods produced per hour of work)
We know that the working age population is increasing at a much slower rate because of an aging U.S. population. All else equal, we can expect Real GDP growth to be .9% less than the historical average. Since 2008, Real GDP has increased 1.2% per year. From 1955 through 2007, the U.S. economy grew at a 3.4% clip. Almost half of the recent shortfall can be explained by slowing population growth. The other half can be explained by decreases in the participation rate, shorter work weeks, and the most concerning element of the post-recession economy, decreases in productivity growth.
Productivity growth is directly related business investment. The more capital expenditures an economy makes, the more productive its workforce can be. Unfortunately, as the graph below illustrates, business investment has been consistently falling over the last five-years. The potential reasons behind anemic business investment are many. Political and economic uncertainty are the oft-cited reasons. Personally, I believe that muted business investment is more a result of low interest rates, and tightening lending standards. High quality issuers have been able to raise debt and retire equity shares that pay higher dividends than its financing rate. Such action has an immediate effect on earnings and is easier than expansionary capex. Meanwhile, smaller companies have had difficulty accessing low cost capital, although this is starting to change as banks loosen their lending standards.
The main point is that if there is a problem with the U.S. economy, it is not with the U.S. labor market, which is robust. And a 160,000 increase in non-farm payrolls does not change this. Moving forward, investors should expect non-farm payroll gains to continue to diminish—a normal occurrence in an economy at or close to full employment. The Fed (and the market) should place more attention to wage gains and average weekly hours worked to determine the pace of interest rate hikes. Meanwhile, the real problem with the U.S. economy is waning productivity and business investment. Over-regulation and ZIRP are culprits.
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