The Causes and Consequences of Slower Growth and Job Creation

The Causes and Consequences of Slower Growth and Job Creation
Carlos M. Pelaez

The economic growth of the US is underperforming past cyclical expansions from sharp recessions with resulting 27 million people in job stress. The objective of this post is relating the consequences of further apparent slowing of the US economy and job creation to its causes of failures of economic policy in the form of unsuccessful fiscal stimulus and legislative and regulatory restructurings that have undermined confidence. Declining confidence is further slowing decisions on investment, hiring and consumption. Policy shift by concrete actions instead of rhetoric is required to reignite the US economy and its private-sector engine of job creation. Continuing financial turbulence is analyzed in (I) and explained in (II) by concerns on Chinese growth and European sovereign risks and banks. The insufficiency of current growth in the US to recover employment is covered in (III). The remaining factors of erosion of confidence in the US are covered by analysis of the failures of economic policy in (IV) and regulatory and legislative restructurings in (V). Economic indicators are discussed in (VI) and interest rates in (VII). The concluding remarks are in (VIII).
I Financial Turbulence. Equity markets had improved substantially in the earlier week but experienced significant turbulence in the current week and continue to trade much lower than their recent peaks (http://online.wsj.com/mdc/page/marketsdata.html ). Financial variables are available with high frequency, daily with market trading, while data on the overall economy become available with a lag of weeks or months. The percentage performance of major US indices was: DJIA -9.9 from the recent peak on Apr 26 to Jul 16 and -1.0 in the week; S&P 500 -12.5 from the recent peak on Apr 23 and -1.2 in the week; and NYSE Financial -16.6 since Apr 15 and -2.8 in the week. The percentage performance of major world stock markets from Apr 15 to Jul 9 was: Dow Global -14.2 and -0.4 in the week; Dow Asia Pacific TSM -9.1 and 0.1 in the week; Shanghai -23.4 and -1.9 in the week; and STOXX Europe 50 -11.3 and -1.0 in the week. The euro strengthened, trading at $1.2930/EUR on Jul 16. The dollar has gained 16.9 percent relative to the euro since the recent trough on Nov 25, 2009, but lost 2.3 percent in the week. The DJ UBS commodity index fell 12.0 percent since the recent peak on Jan 6 and gained 0.5 percent in the week.
The beginning of reports of second quarter corporate earnings on Monday was awaited with optimism by investors. Earnings reports are backward looking information while investment in financial variables is forward looking and observed with high frequency data. The weighing in investment decisions of the probable impact of some deceleration of growth relative to strong earnings reports may have strong influence on financial turbulence. The financial markets of the US were hit on Friday Jul 16 by the combination of weak indicators of industry and sales released during the week and what the market viewed as disappointing corporate earnings. The DJIA dropped 261.41 points, equivalent to a decline of 2.5 percent, courting again at 10,097.90 the barrier of 10,000. All components of the DJIA dropped. The broader market S&P 500 lost 3.1 percent and the Nasdaq Composite fell 2.9 percent. Shares of large financial institutions dropped sharply. The Wall street Journal depicted the markets as hit by fading optimism (http://professional.wsj.com/article/SB10001424052748704913304575370584279739608.html?mod=wsjproe_hps_LEFTWhatsNews ). The yield of the 10-year Treasury dropped to 2.927 percent as risk exposures were abandoned in favor of the temporary safe haven of Treasuries and other highly-rated fixed income securities.
II Confidence Shocks. Two of four global factors of risk in the world economy that affect confidence in financial markets are considered in this section and the other two, failures of economics policy in (IV) and regulatory and legislative restructuring in (V) after analysis of US growth and employment in (III). First, there are recurring doubts on growth of the economy of China that could cause lower commodity prices and weaker interregional trade in Asia with adverse effects on regional and global growth. Doubts on China’s growth resurfaced again (http://www.ft.com/cms/s/0/6bf81ecc-8fb8-11df-8df0-00144feab49a.html http://professional.wsj.com/article/SB10001424052748703609004575354501318242096.html?mod=wsjproe_hps_TopLeftWhatsNews ). The growth model of China is based on developing internal infrastructure with bank credit and a more efficient export sector adding final touches to semifinished imports that are exported as final goods to the rest of the world (Pelaez and Pelaez, The Global Recession Risk, 56-80). The strategy was crafted to absorb labor from the less productive agricultural sector and provide jobs for rapid population growth via infrastructure projects while simultaneously irradiating higher productivity in the export sector to the rest of the economy. The strategy encounters paucity of sound projects in infrastructure with positive present value and slower growth in a flatter expansion path of the world economy. Growth remains vigorous but the doubts persist as to the redesigning of the new Chinese strategy. Second, the sovereign credit risk of several European countries is interrelated with exposures of banks to heavily indebted countries. The Committee of European Banking Supervisors advised stress tests for 91 banks that account for 65 percent of the European Union banking sector (http://www.c-ebs.org/CMSPages/GetFile.aspx?nodeguid=357173cf-0b06-4831-abcd-4ea90c64a960 ). The enlarged list includes segments of the banking industry that are considered weak (http://www.ft.com/cms/s/0/c6f4545e-8e81-11df-964e-00144feab49a.html ). Stress tests are part of an arsenal of tools used by financial institutions in processes of risk management (Pelaez and Pelaez, Globalization and the State, Vol. I, 78-100, Government Intervention in Globalization, 63-4, International Financial Architecture, 112-6). Financial markets were still fractured before Mar 2009. The US engaged in stress tests of major banks and subsequent public disclosure (Pelaez and Pelaez, Financial Regulation after the Global Recession, 164, 170, Regulation of Banks and Finance, 226, 231). Stress tests are useful but it is not feasible to solve ex post unsound exposures with risk management techniques that should have been used with sound judgment ex ante.
III. US Growth and Employment. There are doubts if the growth of the US economy will be sufficient to absorb 27 million people currently in job stress composed of: 14.6 million unemployed (of whom long-term unemployed of 6.8 million or 45.5 percent who have been unemployed more than 27 weeks), 8.6 million working part-time because they could not find a better job, 2.6 million marginally attached to the labor force (who wanted and were available for work and had searched for work in the prior 12 months) and 1.2 million discouraged workers (who believe there is no job for them or had not searched for work in the prior four weeks) (http://www.bls.gov/news.release/pdf/empsit.pdf ). During the recovery phase of similar recession in the early 1980s, GDP grew at the quarterly annual percentage rate of: 5.1 QI83, 9.3 QII83, 8.1 QIII83, 8.5 QIV83, 8.0 QI84, and 7.1 QII84 and thereafter at rates in excess of 3 percent. The rate of unemployment increased from 6.3 percent in January 1980 to a peak of 10.8 percent in December 1982, declining at year end to: 8.3 percent in 1983, 7.3 percent in 1984 and 7.0 percent in 1985 (http://data.bls.gov/PDQ/servlet/SurveyOutputServlet ). US GDP increased at the annual seasonally-adjusted percentage rate of 2.2 in QIII09, 5.6 in QIV09 and 2.7 in QI10 (http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable=2&FirstYear=2009&LastYear=2010&Freq=Qtr ). These rates of growth may be insufficient to recover full employment.
IV Failures of Economic Policy. There are doubts about the effectiveness of economic policy in the US. In May, US exports were $152.3 billion and imports $194.5 billion for a trade deficit of goods and services of $42.3 billion. Exports of goods and services grew by $26.4 billion, or 21.0 percent, from May 2009 to May 2010 while imports increased by $43.8 billion or 29.1 percent (http://www.bea.gov/newsreleases/international/trade/tradnewsrelease.htm ). The Bureau of Economic Analysis (BEA) of the Department of Commerce has revised the trade data for 2009. Total US exports of goods and services in Jan-Dec 2009 were $1570 billion, declining by 14.6 percent from $1839 billion in 2008 and imports in Jan-Dec 2009 were $1945 billion, declining by 23.4 percent from $2538 billion in 2008 (http://www.bea.gov/newsreleases/international/trade/2010/pdf/trad1310.pdf ). The growth in exports in 2010 relative to 2009 is not the result of export promotion by public policy, which is only an intention of creating two million jobs (http://www.whitehouse.gov/the-press-office/president-obama-details-administration-efforts-support-two-million-new-jobs-promoti ), but rather part of similarly high rates of growth in other countries resulting from comparisons with very low levels in 2009. The American Recovery and Reinvestment Act of 2009 (ARRA) consisted of fiscal stimulus of around $800 “that would raise employment relative to what it would be in the absence of stimulus by 3 to 4 million by the end of 2010” (http://news.uchicago.edu/files/newsrelease_20090227.pdf ). The calculations were based on the multipliers of a Keynesian model. The application of this model to the trade balance of the US requires considering income-creating multipliers of exports but also opposite effects from income-destroying multipliers of imports much the same as ARRA-created taxes will have negative income-destroying multipliers. Counterfactual claims consist of empirical issues that are quite difficult to measure such as “what would have been otherwise.” These counterfactuals abound in economics but are almost impossible to prove rigorously (Pelaez and Pelaez, Globalization and the State, Vol. I, 17, 124-5). In this case, proving that the stimulus “saved” millions of jobs requires detailed data on the US economy with and without the stimulus while data are only observed with the stimulus and it is very difficult to separate the effects of alternative hypotheses. Persistent high unemployment raises doubts on the effects of the fiscal stimulus.
V Regulatory and Legislative Restructuring. The failed fiscal stimulus combines with legislative restructurings of key economic activities and widespread and profound regulatory shocks, raising transaction costs that deteriorate consumer and business confidence, in turn paralyzing investment decisions and hiring. The experience of the Great Depression has been misinterpreted and applied to the current recession. In 1929-33, the US economy experienced a decline of employment by 25 percent and of output by 26.7 percent. In 1939, in a truly lost decade, both employment and output were substantially below their levels in 1929, resulting from erroneous policies of the Roosevelt administration in promoting higher prices by support of monopolies and higher wages by support of unions (Harold Cole and Lee Ohanian cited in Pelaez and Pelaez, Regulation of Banks and Finance, 215-7). Amity Shlaes published a must-read book on The Forgotten Man: A New History of the Great Depression, analyzing why the Great Depression lasted until World War II (http://www.amazon.com/Forgotten-Man-History-Great-Depression/dp/0060936428/ref=ntt_at_ep_dpi_1 ). Shlaes has revealingly related the current lack of business confidence that may flatten the path of recovery of the economy to a similar adverse confidence shock by the Roosevelt administration (http://professional.wsj.com/article/SB10001424052748703636404575353431153327248.html ). Confidence doubts creep into the sober acts of the Federal Open Market Committee (FOMC) meeting in Jun: “a number of participants expressed the view that, over the next several years, both employment and inflation would likely be below levels they consider to be consistent with their dual mandate” (http://www.federalreserve.gov/newsevents/press/monetary/fomcminutes20100623.pdf 8). The confidence shock is being magnified by the Dodd-Frank bill (http://professional.wsj.com/article/SB10001424052748703615104575328430427126018.html ), which will sharply increase all the costs of consuming and doing business in the US. Transaction costs consist of costs other than those incurred in production and transportation: negotiation, legal counsel, litigation, enforcement of judgments and many others that are equivalent to almost one-half of GDP (Pelaez and Pelaez, Globalization and the State, Vol. I, 137-8, Government Intervention in Globalization, 81-3). Twenty six pages of flow charts are required simply to illustrate the timeline of the Dodd-Frank bill that will result in 243 rules by ten regulators over a period of at least six months and perhaps 18 months or more (http://professional.wsj.com/article/SB10001424052748704288204575363162664835780.html?mod=wsjproe_hps_MIDDLESecondNews ). Markets resigned to the fact that the shock of financial regulation is over with approval of the Dodd-Frank bill but it is just beginning. An indicative measure of the huge magnitude of transactions costs is that one of the largest banks in the US is assigning one hundred teams solely to examine the legislation (http://professional.wsj.com/article/SB10001424052748704682604575369030061839958.html ). Another large bank estimates that the restrictions on debit-card fees paid by merchants for client transactions may cause a charge on earnings of $10 billion (http://noir.bloomberg.com/apps/news?pid=20601087&sid=a7T01FWuMWtQ&pos=4 ). The capricious regulation of derivatives is likely to create higher costs and uncertainty in agricultural business (http://professional.wsj.com/article/SB10001424052748704258604575361182317501188.html?mod=wsjproe_hps_TopLeftWhatsNews ). The consumer protection agency will asphyxiate consumer credit, increasing rates and lowering limits. The Dodd-Frank bill creates new fees on banks (http://professional.wsj.com/article/SB10001424052748704746804575367290289483772.html?mod=wsjproe_hps_LEFTWhatsNews ) that will likely be passed on as higher rates to borrowers. The regulators crafting the new worldwide Basel rules on bank capital are prudently softening them and postponing their implementation because of concerns of another credit crunch as banks are still recovering from bad loans and write downs (http://professional.wsj.com/article/SB10001424052748704746804575367193230588972.html?mod=wsjproe_hps_TopMiddleNews ). US regulators closed six additional banks in three states on Jul 16, bringing the total for the year to 96 closed banks, doubling the rate of bank closings from 140 banks in 2009 (http://professional.wsj.com/article/SB10001424052748704746804575367193230588972.html?mod=wsjproe_hps_TopMiddleNews ). The timing of the Dodd-Frank bill is highly inopportune because it will add to bank difficulties when credit growth is required to finance the recovery of the economy. The draconian regulation of the Dodd-Frank bill and the hundreds of rules by ten regulators will crush the competitive advantage of US banks in world markets. Financial regulation is exporting the financial industry to other more favorable jurisdictions as it happened with the Bank Act of 1933 (12 U.S.C. § 371a) and Regulation Q (12 C.F.R. 217) prohibiting payment of interest on demand deposits and imposing limits on interest paid on time deposits issued by commercial banks that caused the exodus of US banking to London and other overseas financial centers (Pelaez and Pelaez, Financial Regulation after the Global Recession, 57-8). The individual measures of the Dodd-Frank bill will increase the cost of credit, lowering the volume of loans. The combined measures of the Dodd-Frank bill will make the US financial system more prone to crises and highly restrictive in financing growth and employment creation.
VI Economic Indicators. Recent data are showing weakness in all sectors of the economy, including manufacturing and sales that were leading the recovery. While the Empire State Manufacturing Survey of the New York Fed registered improving conditions for manufacturers in New York in Jul, the rhythm of growth of business activity declined “substantially,” with the index falling from 19.6 in Jun to 5.1 in Jul and falling a cumulative 27 points from the peak of 31.9 in Apr (http://www.ny.frb.org/survey/empire/empiresurvey_overviewexpand.html ). The Business Outlook Survey of the Philadelphia Fed finds that while manufacturing executives expect growing business over the next six months, optimism has declined. The region’s manufacturing activity is expanding in Jul but it has slowed in the past two months (http://www.phil.frb.org/research-and-data/regional-economy/business-outlook-survey/2010/bos0710.pdf ). Manufacturing output dropped 0.4 percent in Jun, following three months of increases around 1 percent. Total industrial production grew 0.1 percent in Jun after increasing by 1.3 percent in May. The rate of capacity utilization for total industry was unchanged at 74.1 percent in Jun, which is below last year’s rate by 5.9 percent points and 6.5 percentage points below the average from 1972 to 2009 (http://www.federalreserve.gov/releases/g17/Current/default.htm ). The advance estimate of US retail and food services sales for Jun measures a decline of 0.5 percent from the previous month but an increase of 4.8 percent relative to Jun 2009; the Apr to May estimate was revised to a decline of 1.2 percent (http://www.census.gov/retail/marts/www/marts_current.pdf ). The combined value of distributive sales and shipments by manufacturers in May fell by 0.9 percent relative to Apr but increased by 11.8 percent from May 2009. Manufacturers and trade inventories rose by 0.1 percent in May relative to April but fell by 1.5 percent relative to May 2009 (http://www.census.gov/mtis/www/data/pdf/mtis_current.pdf ). Initial unemployment insurance claims for the week ending Jul 10 fell by 29,000 to 429,000 relative to the revised 458,000 for the week earlier (http://www.dol.gov/opa/media/press/eta/ui/current.htm ). The delay this year of manufacturing retooling does not permit accurate reading of initial unemployment insurance claims. The producer price index fell by 0.5 percent in Jun relative to May but increased by 2.8 percent in the past 12 months (http://www.bls.gov/news.release/ppi.nr0.htm ). The consumer price index fell by 0.1 percent in Jun relative to May, increasing by 1.1 percent in the previous 12 months (http://www.bls.gov/news.release/pdf/cpi.pdf ).
VII Interest Rates. Faster expansion of the economy may be arrested by an unsustainable US debt galloping toward 100 percent of GDP with plans of financing it with tax increases as well as by the inevitable increases in interest rates of unwinding the Fed’s balance sheet (http://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1 ) and relaxing the zero interest rates on fed funds. Treasuries are still used as safe haven for temporarily unloading risk exposures during moments of stress such that the yield of the 10-year Treasury has declined to 2.93 percent on Jul 16 from 3.06 percent a week ago and 3.19 percent a month ago. The 10-year government bond of Germany traded at 2.61 percent on Jul 16 for a negative spread of 31 basis points relative to the comparable Treasury (http://markets.ft.com/markets/bonds.asp ). Relative European and US risks are changing with the dollar depreciating to 1.2930/euro.
VIII Conclusion. Growth in the US is insufficient to improve the plight of 27 million persons in job stress. It is still uncertain if the deceleration of economic growth in the US, and most other countries, is temporary and there is no certainty on the rate of growth in the expansion. There is certainty of not repeating the jump from a seasonally-adjusted annual rate of growth of GDP of -6.4 percent in the second quarter of 1982 to 9.3 percent in the second quarter of 1983 and a compound average of seasonally-adjusted annual rates of 7.7 percent measured with the six quarters from the first quarter of 1983 to the second quarter of 1984. The V-shaped recovery from deep recessions has been crushed by failures of economic policy. Fiscal policy appears to be crowding out private sector investment and job creation. Confidence shocks resulting from regulation and legislative restructurings have paralyzed US companies that are holding two trillion dollars of cash instead of investing and hiring. More ambitious measures to change most economic activities for an alleged better world decades ahead, when we all may be dead after national bankruptcy, should be replaced by a policy shift of recovering business and consumer confidence. That policy shift will prove more effective in promoting faster economic growth that will alleviate the actual job stress of 27 million people and of the rest of the population who will breathe in relief of the threat of potential job stress. (Go to http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10 )