Perceptions Still Matter

 | Sep 28, 2011 | 5:00 PM EDT  | Comments
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I have to wonder, why are so many people concerned with labels? Recession? No recession? To most Americans concerned about jobs, it doesn't really matter whether the economy expands slightly or contracts a bit. What matters is whether the economy is growing above its "trend" rate of growth, which is when unemployment will come down.

The "trend" rate of growth is basically determined by the growth rate of the labor force and productivity gains. If the economy grows above that rate, job creation will be sufficient enough to rehire some of the unemployed and absorb new entrants to the labor force. On the other hand, if the economy does not grow faster than productivity gains, we can still see positive economic growth data, even while the economy loses jobs. It might not mean companies turn to outright dismissals of their staff, but it could mean that people leaving jobs simply aren't replaced.

Let's talk about productivity a bit more, before we get into a discussion of economic growth and the public's perception of economic growth. The word "productivity" can conjure up workers producing even more widgets per hour on an assembly line or answering more call center phones every minute. That could be the case, but often, it isn't.

Bank of America (BAC) recently announced that it is cutting up to 40,000 jobs and closing 600 branches. This is productivity in action. How? Think of online banking. I don't need a bank teller or a call center employee to help me with my basic questions or needs, so the bank can cut those jobs and close those branches without sales suffering. The same sales with less input of labor hours means higher productivity, even though an individual worker might not be working any harder.

The basic premise of productivity gains across different industries is the same: The economy has to grow faster than the rate at which companies, in aggregate, are able to maintain or increase their sales without adding staff (or even reducing their workforce, as the case may be). Productivity gains in recent years, according to data from the Bureau of Labor Statistics, have generally kept pace with output growth, though productivity fell in the first and second quarters of this year. In 2010, productivity grew by 4.1%, but GDP grew only 3.0%. No reason to add much to staff at that rate, when the existing staff levels are sufficient to increase output.

However, declining productivity isn't good, either. In the first and second quarters of this year, productivity fell by an average of about -0.65%, while GDP grew by an average of 0.7%. That reflects rising unit labor costs at an average annual rate of 4.75%, which makes companies much more likely to try to control labor costs by introducing even more reliance on productivity gains going forward. That can mean less hiring and/or reduced real wages.

In an ideal world, we would have productivity gains with even more output growth. Right now, we don't have that. Growth in the first half of this year, by an average 0.7% annual rate, is less than the population growth of about 1% annually. With roughly 1% population growth and productivity gains that tend to be around 2% per year, historically speaking, we need economic growth of 3% just to keep unemployment from rising. We need about 5% GDP growth for a full year to bring down unemployment by one percentage point. The economy has a higher hurdle to clear than merely a breakeven between expansion vs. contraction for it to matter to the general public.

Instead, we are getting much less than that. Two data points released earlier this week speak to both growth and sentiment. First, the Chicago Fed National Activity Index's reading for August, for the three-month moving average, was -0.28, following a -0.27 print in July. In this metric, "zero" indicates "trend" economic growth, and a reading above "zero" means the economy is growing above trend -- and thus, can reduce unemployment.

Meanwhile, negative numbers, but above -0.70, indicate low growth, below the economy's potential; readings below -0.70 are generally consistent with recessions. So, this metric indicates that we might not be at recessionary levels right now, but the public senses that we are not getting enough growth to improve their finances.

One indicator that captures the public's mood, however, is Consumer Confidence. The August plunge in confidence wasn't just a blip -- the headline from the Conference Board's sentiment index increased only by a tiny bit in September to 45.4 from a revised 45.2 reading in August, which was the lowest since April 2009, when the economy was in a recession. A healthy reading is 90, and a reading of 100 generally indicates robust growth. Importantly, the "expectations" component, which has a higher correlation with future spending patterns than does the headline measure, was a recessionary 54, up just a tad from last month's 52.4.

The survey also captures that which matters most to many people – jobs. The share of consumers who said jobs are currently hard to get increased to 50, the highest level since May 1983 (following a deep recession then), from 48.5 in August. As long as the economy can grow through productivity gains instead of through hiring, many people will believe we are in a recession, no matter how much economists may quibble and quarrel about the probability of applying that label. As long as consumers' pessimistic views threaten to restrain their spending, businesses' low confidence in the economy may keep them from committing to adding new staff if any rebound in the economy is perceived to be temporary, and they will rely on productivity gains instead to meet any increase in demand. That indeed is the Catch-22.


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