On The Economy -- Pain But No Gain

Jan. 14, 2005
Squeezed profits and big benefit costs keep companies from adding jobs.

Even though the U.S. economy came roaring back during the third quarter of this year, with a real growth rate of almost 4%, payroll employment posted another puny gain, with an increase of only 300,000 workers, or less than 1%. Just what is going on here?

One possibility is that inflation-adjusted growth is significantly overstated. Another possibility is that eventually employment will pick up, but it lags real growth. Another possibility is that payroll employment growth is understated, and household employment growth is a better figure by which to measure job creation. Still another possibility is that there has been a fundamental change in the U.S. economy -- and for many years in the future we will have robust growth accompanied by very few new jobs created, with most of them at sub-par wages.

Maybe the real growth in the U.S. economy is overstated because inflation is understated. However, most of the gains in the third quarter were in sectors affected by inflation: cars, housing, machinery and exports. I don't think there was much funny money in the GDP accounts last quarter.

Because changes in payroll employment do indeed lag changes in the growth rate by about one quarter, it is possible we will see a much more vigorous gain in employment during this final quarter of 2004. However, the dichotomy between real growth and payroll employment has now grown steadily for over three years, and I don't think a one-quarter lag can be used to explain the latest difference. Because the household employment numbers (the number of people over age 16 employed in each household) jump all over the map from one month to the next, they can't be used as a reliable guide for measuring short-term changes in actual employment. Seasoned economists know not to go there.

On the other hand, these figures do tell a compelling story over a longer time frame. And without going into all the economic detail, suffice it to say that when looked at through the lens of the ratio of employment to the working age population in the U.S., the Labor Department's household survey of employment compared very favorably with the department's payroll survey of employment.

By now we know what is happening. People are fired or laid off. Either way, they are permanently removed from the roles of big corporations. They resurface as self-employed, and in some cases they work but aren't counted because they labor in the underground economy. Why aren't corporations hiring more people? Wage gains are fairly moderate. One reason is that profits are still being squeezed: The ratio of domestic profits to GDP now stands at only 6.5%, down from 7% at this point in the previous recovery, when margins were also below average.

The other reason payroll employment gains are so minuscule is that while wage gains are modest, fringe benefit costs continue to rise at double-digit rates. Thus people are either hired without paying those benefits or -- more likely -- not put on the payrolls at all but hired as independent contractors. Both major presidential candidates in this year's election, of course, had a plan to reverse this spiral. However, if by some stretch of the imagination they were kidding, and these costs continue to rise at double-digit rates, we can reasonably expect payroll employment to show little or no gain in the next four years, even under robust growth, as more and more people become self-employed.

Michael K. Evans is chief economist for American Economics Group, Washington, D.C., and president of the Evans Group, an economics consulting firm in Boca Raton, Fla.

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