Faced with unemployment and underemployment running at 17 percent, the “Great Recession” is following a pattern that suggests the developed countries and especially the United States face a structural employment problem, rather than a cyclical one.
Labor, capital and commodities are the most important factors of an economy. Unlike capital and commodities, labor cannot be freely traded. Companies can place their operations in locales where labor is plentiful, low cost and reasonably skilled. In fact, the skill levels in India and China are rivaling those in the developed countries. The cost to perform the same job differs significantly in country by country. Process design, education, new technologies and digital communications are contributing to this structural imbalance.
Benefits of Low Labor Costs
Over the next decade, the total number of people with the necessary education and access to technology will dwarf the total labor force of the United States. While a boon for much of the world, the negative affect on the United States will be long lasting. To compete effectively in the global market, the price differential between the emerging countries and the developed countries must narrow. Yes, the pay scale in the emerging countries will rise. However, they are starting at very low rates. Instead, unemployment in the developed countries will remain stubbornly high.
The chart below is from the McKinsey Quarterly “Globalization’s critical imbalances” though charts like it are available elsewhere. The point is recovery form the latest recession is following a different path, especially for labor. Not only is the unemployment problem worse, it is not recovering sufficiently to absorb all those who have lost their jobs and the new entrants.
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The problem is the developed countries do not want to lower their pay scale to match the competition. As democracies, they look to their elected leaders to resolve the issue. The politicians face difficult choices. Spend more on programs without increasing taxes to pay for it. Or lead with austerity programs that attack the structural problem and face the wrath of the electorate at the next election.
Government spending is not generating the growth in the GDP of the developed countries necessary to employ meaningfully all those in need of work. The United States needs at least 3.0% growth to employ the growing population, as between 100,000 to 125,000 people enter the work force each month on average. Growing at 3.0% does not help the more than 8 million who have lost their job and are looking for work. To help these people the economy must grow at a faster rate. However, that is proving to be difficult. Normally the United States economy grows at a 7% rate following a recession. This time it is different as the chart above shows.
Difficult Choices Lie Ahead
The pressure to reduce the deficit will act as a drag on the economy. A 1% cut in the deficit will lower the GDP by 1%. The counter idea does not work as shown by a comprehensive study by Christiania Romer, President Obama’s head of the council of economic advisors. Adding another 1% in deficit spending adds less than 1% in GDP and in some cases may be even negative for GDP growth. Government spending is not the answer. According to The University of Chicago’s Harald Uhlig, the United States loses $3.40 of output for every dollar of government spending.
Add in higher tax rates the “Bush” tax cuts roll back in 2011 and we will get a further drag on the GDP. This comes as national state and local governments are struggling to reduce their spending. When they do, they contribute to a short-term contraction in the GDP growth. Longer term this cut back in government spending will translate into more money in the hands of consumers. When they spend, they contribute to the growth of the country in productive ways.
Unfortunately, the people who are being hurt the most are those with less than high school educations. Next are those that only finished high school followed by those with some college education and finally the best off are anyone who completed their college education. This isn’t surprising as the high cost of labor in the United States requires that people come equipped with education and skills that can justify their salary.
This pattern of high unemployment will continue for many years, especially as the economy struggles to keep up with those entering the work force. Unfortunately, there are no easy solutions as the large and growing deficit hampers growth, and any attempt to raise taxes will slow the economy further. The Age of Austerity is here and we will have to live through the structural changes in the economy and employment. The economy will go through frequent recessions as it rings out the economic dirt.
What is an Investor to Do?
Investors face a new reality. Instead of buying and holding, they must adapt to the higher volatility in the markets. This creates new opportunities as well as challenges. We must be selective in our buying and recognize that a time will come to sell and move on to the next good opportunity. By focusing on the sectors and sub-sectors that will experience the best growth opportunities, investors can adroitly adjust their portfolios to reflect this new reality. Managing risk will be essential. Adjust your thinking to be successful.
