The Great Labor Disconnect

In a recent column, I gushed enthusiastically about the stock market as if it was on a one-way trip higher. It's an old truism that such predictions are usually the sign of a top, and it looks like this time the joke was on me. Regardless of what stocks do now, I was too positive at the time.

One thing I did get right in that column was to start off by calling myself a long-term bear because of deeper problems in the economy that most people seem to be missing. The main worry is the deepening inability of capital to produce jobs, which I will address today.

Compiling data from the Commerce and Labor Departments, I discovered an ominous disconnect between U.S. employment trends and economic growth.

Source: Commerce Dept. / BLS

This chart compares the year-over-year change in real GDP with the change in non-farm payrolls. Between 1950 and 1995, the economy often grew faster than employment, but it always corrected back every few years. This makes sense: Early in an economic expansion, companies hesitated to hire new workers. But as conditions improved, they loosened purse strings and jobs snapped back. That's why employment has always been a lagging indicator.

Starting in the mid-1990s, the economy started growing faster than employment and hasn't looked back since. This mainly results from the rising trade deficit, which has helped relocate jobs overseas.

Source: Federal Reserve

These charts demonstrate a secular trend underway where production and capital now bypass American labor. There are countless anecdotes of this process, one of the most recent being a Manpower report that corporate hiring plans are now at the lowest since at least 1982. (That encompasses three previous recessions for comparison's sake.)

Many people will blame regulation, taxes, education and health-care costs for this trend. While I am sure all these factors play a role, the simple economics cannot be denied: In many other parts of the world, labor is cheaper and the return on investment is higher.

To understand why, consider the rise of the U.S. Sunbelt. During the Great Depression and World War II, the Roosevelt Administration channeled as much spending as it could to the South to help it modernize and to drive up its low wages. As I discussed in a previous column, this Keynesian project was designed to promote consumption and homebuilding as a way to encourage aggregate demand.

Why the Sunbelt? If a southerner's income went from say $500 a year to $3,000, he would move from a poor country house without electricity to a suburban subdivision. His family would abandon subsistence farming and start buying Campbell's Soup and Kraft macaroni and cheese at the grocery store. They'd also start using refrigerators, automobiles and washing machines, building a reliable market for frozen foods, gasoline, electricity and Tide detergent. This is how millions of people became consumers.

The increasing role of women in the workforce complimented this process, with the proportion of women over 16 working outside the home almost doubling from 29.9 percent in 1948 to 57.5 percent in March 2000. This helped drive the business cycle and profits because every time a woman left the home for an office it increased demand for those time-saving consumer products. The production of goods and services migrated away from the domestic sphere and toward the business sphere, where they drove the corporate economy we investors know and love.

Since 2000, the proportion of women who are employed has fallen to 55 percent. While this process probably won't go into reverse, it has peaked at a level that reflects a critical mass of women who prefer being mothers or not working at all. Simply by not growing, this process deprives the economy of a 60-year tailwind. (It also explains why consumption grew increasingly dependent on leverage rather than rising employment after 2000.)

An even worse piece of economic news is that the rise of women workers has masked a disturbing decline in male employment from a proportion of 81.6 percent in 1948 to 64.6 percent today. And, it's been dropping much more quickly since 2000: Down 6.6 percentage points versus 2.5 percentage points for women.

Source: BLS (Not seasonally adjusted.)

We're witnessing a major disconnect form between capital and labor. The scary thing is that this might actually be normalcy, while the high levels of employment we knew the last 50 years were the aberration. After all, before the 1920s, about one-third of Americans worked on farms. Is it possible for non-farm payrolls to employ the entire country on a truly long-term basis? One of the reasons why it worked for so long was that the government encouraged consumption to prevent another Depression, and created transfer payments like the earned-income tax credits to subsidize consumption. What happens now that the much of the model is broken?

Today, China, Brazil and India are playing the role of Alabama, Georgia and North Carolina 60 years ago, while the U.S. at large resembles cities such as Philadelphia, Utica, and Camden circa 1950. It's not pleasant to speak about one's own country in such a way, but these are basic structural issues that cannot be ignored. It explains why capital is gravitating away from the U.S., and why energy prices have risen so much faster than global GDP: India or China might grow 10 percent, but their car ownership is rising 2-3 times faster. (One unit of GDP there has more impact than a unit of GDP in the U.S., just as occurred in the Sunbelt versus the North 50 years ago.)

The current situation also resembles the period immediately surrounding WWI, when the U.S. economy doubled in nominal terms thanks to massive exports of war materiel to Europe. Precise numbers aren't available that far back, but we know the trade surplus exploded higher, allowing the U.S. to repay its debts and lend billions to the U.K. and France so they could keep buying our guns and butter.

Fast forward 80-90 years and the roles have changed. China and other countries lend trillions to the U.S. so we can keep buying their sweaters, cars, shoes, wallboard, electronics, oil, salmon and pharmaceutical chemicals. This is now a structural obstacle to employment because companies are more dependent on foreign supply chains than ever before. We increasingly resemble dysfunctional Latin American economies of 20 years past that relied heavily on imported goods despite high unemployment.

In the 1920s, France successfully inflated its way out of the problem by ditching the gold standard. We've tried to do the same thing with 0 percent interest rates, but it's hard to debase your currency when it has the same function in the global economy as bullion did in 1920. After all, most big companies' purchasing contracts with Asian suppliers are denominated in dollars over periods of several years, so the benefits of devaluation will be felt at a glacially slow pace. Oil, on the other hand, is re-priced in dollars several thousand times a day.

For more than 150 years, the American economy grew as capitalists (like all of us) found new ways to earn profits from the economy. That process followed certain social patterns that are reversing in the U.S., which will cause a long and difficult adjustment for our country. The good news is that the same social processes that drove the U.S. economy for decades are now taking root across emerging markets, where investment opportunities will abound for years to come.

 

** Editors Note: Catch David debate Michael Pento on inflation! Segment will air on next Tuesday's Market Neutral podcast, available 6-30-09.