By Robert E. Prasch
We all know that predictions in economics can be fraught. This is for a variety of reasons, with the absence of controlled experiments high on the list. However, over the years we have learned a few things through the observation of regularities and by deducing from the things about which we are reasonably certain to formulate conjectures about things of which we are less certain.
With this in mind, let us consider the December jobs report. By all accounts, it was a “disappointing” result with only 74,000 jobs created. The “headline” rate of unemployment did fall appreciably, but that was solely and completely due to an increase in the number of people who have entirely given up looking for paid work. While we can all agree that the result is disappointing, I would like to take issue with the almost ubiquitous report that it was “surprising.”
To understand why it was not surprising, let us review what is known about macroeconomics. Business hire when their current and projected revenues increase relative to costs. We also know that employees’ wages and interest paid on previous debts constitute a substantial portion of costs. Since the median US wage has fallen considerably since the recovery began, and interest rates have been and remain remarkably low, we know that these do not constitute barriers to hiring.
The problem, it follows, must be on the part of revenues. Total revenues are, in the parlance of macroeconomics textbooks, called Aggregate Demand. It is constituted of four broad components: consumption expenditures by households; net trade flows (exports minus imports); “real” investment in plant, equipment and inventories (not to be confused with the purchase of stocks and bonds); and net government spending (government outlays minus taxes collected). Let us examine the status of each of these components in turn.
American consumers were, by 2007, famously over-leveraged. A lot of this was mortgage debt, but we also know that debts associated with credit cards, student loans, and automobiles were all at or close to all-time highs. Since the crash, many if not most households are trimming their debts. Others are having their debts reduced involuntarily through foreclosures or bankruptcies. It is also no secret that many lenders have imposed more stringent standards on lending in the form of higher collateral or FICO scores. In short, a reduced capacity and willingness to borrow conjoined with a steadily decreasing median wage has been holding back spending from this sector. Any “wealth effect” on consumption emanating from a recovered stock market will not be enough to offset this drag (although hoping for the latter constitutes almost the entirety of the Fed’s and White House’s recovery strategy).
Net exports, that is to say total exports minus imports, have constituted a large net drain on aggregate demand since the Reagan Administration. There are several reasons for this that need not detain us now. The good news, if we can call it that, is that weak consumer demand has meant that we are not importing as much as previously. This reduction has more than offset the weakened demand for our own products from Europe, which is famously having its own economic difficulties. In sum, our deficit in net exports still constitutes a drain on aggregate demand, but not as large a drain as previously. Let’s call this news “mixed.”
Businesses invest in plant, equipment and inventories when current and anticipated revenues are rising. Seeing such an increase contributes to both the optimism of a firm’s managers even as it enhances their ability to convince a lender that they will be able to pay back any loans they need to make these investments. However, with consumer purchasing constrained and net exports still negative, albeit not as negative as they formerly were, there is little reason to invest other than for the purposes of replacing decrepit equipment. That said, we have seen some recovery in business investment, although it is still well off its pre-recession highs.
This leaves us with net government expenditures. As we all know, the Washington establishment has been fixated on a presumptive “crisis” in deficit spending by the federal government. Not explained, at least not coherently, is why they are all in a tizzy over the subject. Either way, the federal government’s deficit is shrinking rapidly. Additionally, we know that expenditures by states and municipalities have been shrinking for some time. Overall, it is evident that the government sector is reducing its contribution to aggregate demand.
So, lets sum up. Consumer expenditures are highly constrained by previous debt and the felt need of consumers to save more even as banks have become more particular about lending. Net exports are a drain on aggregate demand but not as substantial a drain as previously. Investment is growing but still well off its highs as business revenues are not rising substantially (this, and not “excess regulation” from Dodd-Frank, is the reason that banks have curtailed lending to them). Government is, after years of bi-partisan clamor on the subject, fixated on reducing its deficit and thereby reducing its net addition to aggregate demand.
Absent anything driving aggregate demand, can we be surprised to learn that overall spending is failing to grow at anything like the pace required for a robust economic expansion? We have every right to be disappointed, but no cause to be surprised, by December’s employment numbers. Moreover, while future employment numbers will likely be better (they really can’t get much worse), we will not likely see numbers at or above the population growth rate, and thereby a rise in the labor force participation rate, until at least one of the components of demand described above begins to grow substantially. That, regrettably, is unlikely to be soo