The Economy -- Market Masks Recovery

Dec. 21, 2004
Events on Wall Street belie overall economic picture.

In Manhattan's poshest eateries, $500 bottles of wine now languish in the cellars. In Silicon Valley anyone can purchase a Porsche with no waiting. In Las Vegas dealers who usually supervise the high-stakes players are reassigned elsewhere in the casinos. In Miami's South Beach, trendy resorts report average daily receipts are down 10%. So for wine merchants, exotic car dealers, casino owners, and overpriced hoteliers and restaurateurs, it is indeed a recession. But how about the rest of the country? There have been layoffs in the traditional areas where recessions hit hardest, namely durable-goods manufacturing. Over the last three months employment in that sector has declined 217,000, an annual rate of almost 6%. Employment in nondurable-goods manufacturing has fallen an additional 83,000, or an annual rate of 4.5%. Yet over the same period, total private-sector employment has increased 261,000, mostly in services. In addition, public-sector employment has risen 134,000 over the same period. Thus, from November through February, the period during which some claim the economy has been in a recession, total payroll employment has risen 395,000, or at a 1.2% annual rate. What happened the last time the U.S. economy had an actual recession? During the nine-month period officially defined as the recession, total manufacturing employment fell 686,000, or 229,000 per quarter, not much different from today. However, nonmanufacturing employment also declined, falling 853,000, or 284,000 per quarter, compared to a 395,000 gain now. So it isn't that manufacturing is less important now than it used to be. Rather, nonmanufacturing employment is acting in a completely different fashion now than in 1990-91, continuing to rise at average rates instead of declining significantly. Several factors caused this dichotomy, but the main one is that the events leading up to this slowdown in the economy did not even remotely resemble previous business-cycle peaks. In the past, business-cycle peaks invariably occurred when a combination of bigger gains in wage rates and smaller gains, or outright declines, in productivity boosted unit labor costs and prices, leading to higher interest rates and tighter credit conditions. Once the downturn started, firms quickly jettisoned excess employees. Nothing of the sort happened this time. While one can quibble with the most recent productivity data, it is clear that productivity growth accelerated rather than declined in recent years, rising a phenomenal 4.3% last year, and unit labor costs rose only a minuscule 0.7%, far below the core rate of inflation. When the downturn did occur, firms did not begin to terminate excess workers, because for the most part there weren't any. Virtually the only exception has been in the auto industry. From 1996 through early 2000, the overall economy grew much faster than anyone anticipated, and so did the stock market. Hence, many claim, the shocking losses in the stock market will pare real growth proportionately. However, suppose that in fact the rapid growth in the stock market in the late 1990s was caused by unusually rapid growth in domestic consumption and investment, rather than the other way around. I think rapid growth occurred because of (a) the switch from budget deficit to surplus, (b) the lack of any increase in core inflation at full employment, (c) the accompanying decline in real interest rates, and (d) the unusually rapid growth in productivity. The stock market benefited from these developments, but was not the cause. Of all the factors that have sparked recessions in the past, the only one that applies currently is the whopping decline in the stock market. However, the recent decline needs to be kept in perspective. The S&P 500 did plunge 40% from late August to mid-October 1987, and the economy kept rolling merrily along. Also, it plunged almost 30% in the spring of 1962, yet the effect on total GDP was too small to be measured. The stock market has abdicated its role as a leading indicator, and now lags current events. I believe that soon after the beneficial impact of interest-rate cuts (the decline in long rates that started last June as well as the Fed cuts that started in January) become clearly visible even to Wall Street analysts, the stock market will stage a major rally, adding a modest boost to an economy that already is well into its recovery phase. Michael K. Evans is president of the Evans Group, an economics consulting firm in Boca Raton, Fla.

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