Productivity used to have a cyclical component. It fell early in a recession, and it rose early in the recovery. The early-recession fall resulted from falling sales and no employment change. The idea is that businesses see the sales decline, but don’t know if it is temporary. So, they don’t layoff for a while and productivity falls.

The early-recovery productivity growth is similar. A business sees increasing sales, but is unsure if it is permanent. So, they avoid adding to payroll until they are confident that the higher sales will be maintained.

All that went away with the past two recessions. In these recessions, productivity growth was relentless, increasing quarter after quarter. Consequently, our models cannot effectively use the new productivity information. (Don’t ask why. It is a statistical answer.)

Some, very few actually, are discounting the new jobs data, because it included the Verizon strike. We note that it also included the return of Minnesota’s government workers, significantly reducing the Verizon impact.

There are other reasons to be concerned about the new jobs data. A big one is that the previous two months were revised down. June was revised down 26,000 jobs (56 percent) to only 20,000, while July was revised down a whopping 32,000 jobs (27 percent) to 85,000. These revisions imply that the initial estimate is currently biased high, implying in turn that we actually lost jobs in August.

The combination of falling productivity and job losses is a powerful indicator that the second dip may be here or coming very soon.

Downward revisions to United States gross domestic product (GDP) have driven most of the revisions. For about two years, we had trouble with the original GDP estimates. Our jobs forecasts were pretty accurate, but we forecasted productivity growth and consumer spending growth below the initial estimates. This caused us enough grief that we’ve been reviewing our models. Well, the revised numbers are entirely consistent with our original models.

Downward revisions to productivity growth and consumer spending are what drove the downward GDP revisions.

Enough bragging. What is happening to the economy? We’re seeing a weak recovery.
Increasing numbers of forecasters, spooked by weak numbers and downward revisions, are now forecasting a double-dip in the near future. We don’t think that is the most likely case.

We’ve said all along that this would be a weak and inconsistent recession, and that appears to be what we are seeing. Some encouraging data might come in this week. The next week could see weak data. This is exactly what we expect to see in a recovery where financial institutions are wounded, real estate is weak, and consumers over extended.

So, we don’t expect a double-dip recession. We expect continued slow growth, accompanied by weak real estate markets, weak consumer spending, slow job growth, and persistent high unemployment.

That would be the good news and the bad news.

Another recession is in our future though, and not just because the business cycle has not been repealed. However, the timing of the next recession is really difficult to forecast, because in part, the timing will probably be politically driven.

I have become convinced that the culmination of Europe’s problems will be a partial breakup of the Eurozone. Perhaps it will be complete breakup. It really doesn’t matter.

Any breakup will almost surely be accompanied by financial and political crises. These crises will initiate a new recession, one that will be impacting an already weakened economy. It’s likely to be very painful.

The BLS’s July Employment Situation was released today. Non-farm jobs grew by 117,000, highly focused on healthcare, (31,000), retail, (26,000), manufacturing, (24,000), and mining (9,000). Despite the increase in jobs, the measured employment level, an alternate measure of workers, decreased. That decrease was met by a larger decrease to the civilian labor force, causing the unemployment rate to fall from 9.2% to 9.1%. The unemployment rate has hovered in the 9.0 to 9.2 percent range for four months.

Government jobs continue to trend downward, (-37,000). This reflects state governments’ attempting to balance their budget and is also impacted by the partial shut-down of Minnesota’s government.

There were revisions to May and June’s non-farm jobs numbers; May’s jobs increase was revised up from +25,000 to +53,000 and June’s jobs increase was revised up from +18,000 to +46,000.

The long-term unemployment situation still has 6 million persons unemployed for 27 weeks or more, with 1 million discouraged workers, 1 million marginally employed, and 8 million persons on part-time employment due to economic reasons. This presents a clear lack of supply for jobs, a very weak job market. Many workers are choosing part time jobs rather than face unemployment. This illustrates that 10% of the civilian labor force is not the optimum or preferred employment situation.

Private non-farm job growth has been positive while public sector job losses have offset those gains for three months in a row. Companies not optimistic about a vigorous recovery have found little harm in simply waiting. State, local, and even now federal governments have all come under budget scrutiny, greatly hampering their ability to directly affect unemployment. With many of their tools and policies tied up in the banking crisis, there seem to be few initiatives on addressing the needs of the labor market.

Non-farm jobs increased 54 thousand over April, consisting of a gain of 83 thousand in the private sector (I forecasted 240 thousand), and a 29 thousand job loss in the public sector (I forecasted a loss of 18 thousand).

What sectors drove the the slowdown? There was a 30 thousand job slowdown in manufacturing jobs, a 70 thousand slowdown in retail jobs, a 40 thousand job slowdown in leisure and hospitality, and a 20 thousand job slowdown in education and healthcare.

The decline in Retail is interesting.  The sector is experiencing a secularly growing share of online sales, which overall, will reduce the demand for workers. Also, there are technology adoptions that have yet to fully play-out. For example, self-check stations are now at major grocery stores, but they are probably not yet responsible for half the check-out volume. But, we can expect they will eventually be responsible for much more than half the check-out volume. Another thing that I worry about is that consumption growth is now under trend and could stay that way due to high consumer debt levels. These, and relatively high unemployment levels, could imply weak Retail job growth in the near term.

The other part of this jobs report contains results from the household survey, which indicates changes in labor force and unemployment. The labor force jumped substantially in May, by 272 thousand people. This was only slightly offset by a rise in 100 thousand people reporting themselves as employed. As a result, the unemployment rate rose from 9.0 to 9.1 percent, much different than my forecast of a fall in the unemployment rate.

This month’s Employment Situation highlights the fragility of the economy. Manufacturing has been one of the few bright spots in the economy since the Great Recession. If a global slowdown is taking hold as some are predicting, this will have a cooling impact on manufacturing jobs and the economy that will last beyond May.

From the April results, the broad measure of unemployment (including under-employed & marginally attached to labor force) was still 15.9 percent and there were still almost 6 million persons who had been unemployed more than 27 weeks.

The data for May comes out this Friday, June 3.

We do not think the oil price impact is huge, but overall it is a bit negative. There are positives in the Extraction sector, but those are more than offset by negatives in transport and durables manufacturing sectors.

Since February, nonfarm payrolls have increased by more than 220 thousand each month, and we forecast that about 220 thousand occured in May. This forecast reflects a slight slowing in both goods producing industries and in service producing industries. Government sector hiring will be down, dominated by declines in state and local government, which more than offset increases in hiring by Federal government.

The gap between the establishment (payroll) jobs measure and the household survey employment last month was probably an anomoly, and will be corrected at some point. I assume that correction began in May.

Regarding labor force, we project an increase of 99 thousand, a moderate increase. This follows March and April increases of 160 thousand and 15 thousand respectively. The combination of the labor force and the employed persons increase imply that the unemployment rate falls by three tenths: from 9.0 percent in April to 8.7 percent in May.

Our labor market forecast is improving, slowly. Both February and March nonfarm payrolls increased by about 200 thousand, and we are tentatively confident that about 180 thousand can occur in April. This forecast reflects a small pickup in goods producing industries and a slight slowing in service producing industries. Government sector hiring should be similar to March, which was a decline of 14 thousand jobs.

With a similar gap between the establishment (payroll) jobs measure and the household survey employment measure as occurred in March, this would give a change in employed persons of about 256 thousand.

Regarding labor force, we project an increase of 114 thousand, a moderate increase. This follows March’s increase by 160 thousand. The combination of the labor force and the employed persons increase imply that the unemployment rate falls by one tenth: from 8.8 percent in March to 8.7 percent in April.

Zooming back out to a big-picture point of view: the economy is still not firing on all cylinders. There is evidence that the economy is moving back toward all cylinders, but at a slow pace. As a result, job gains will be moderate, and the unemployment rate will remain relatively high.

Forecasting is a challenge in rapidly changing times, and these are very rapidly changing times. At the beginning of the year, it would have been unbelievable if someone had said that Mubarak would be deposed, we would be in a war in Libya, and there would be general uprisings throughout the Middle East, and all in the first quarter. But all this and more happened. Certainly Japan’s earthquake, tsunami, and near nuclear meltdown were unpredictable.

Because of the uncertainty, it seems particularly important that we provide our assumptions to forecast users. First though, you should know that we have included the impacts of the of Japan’s tragedy as best we can. We assume that their exports to the United States will fall only minimally, while their imports will increase. We also take the aggressive assumption that they will complete rebuilding in only eight years, increasing world gross product and demand for United States exports.

There are other issues with Japan that we cannot model. Because of our integrated world economy and just-in-time inventory management, Japan’s manufacturers may be suppliers of critical components of products that are ultimately produced almost anywhere. To the extent that rolling blackouts and other infrastructure issues interrupt Japan’s manufacturers’ ability to promptly deliver critical goods, worldwide production could be hurt. It is impossible to know exactly how important this is, but we believe it will be small relative to world output.

High oil prices pose the most real and immediate risk to United States economic growth, but forecasting political changes in the Middle East is impossible. But of course, oil prices have huge economic impacts. While it seems to be general consensus that the Great Recession’s proximate cause was financial in nature, Jim Hamilton at UC San Diego provides very compelling evidence that high oil prices were a significant contributor.

For our baseline forecast, we assume that world oil prices do not exceed $120 barrel. We also provide an alternative scenario where prices reach $150 per barrel. This scenario generates another recession. The recession appears to be moderate, but we must remember that this is a change in output from a low base. Our unemployment is still very high. The higher oil prices go, and the faster they rise, the worse the recession. Certainly, the forecasts of potential oil prices go much higher than $150 a barrel. Our scenario is thus only suggestive of the economic impacts of general Middle East turmoil.

United States and world financial institutions are still not recovered from the crisis of September 2008, which implies a susceptibility to new financial shocks. For our forecast, we assume no new significant financial shocks. However, the possibility of new financial shocks cannot be ignored. The possibility of some sort of Eurozone crisis arising from the sovereign debt issues of several European countries is relatively high. It is our opinion that the Eurozone is too large to be a single currency. Ultimately, it must break up. How the breakup is accomplished will have major economic consequences.

Problems in United States’ municipal markets could also provide a problem for our already-weakened financial sector. States and local governments are facing very serious financial challenges, and it appears that citizens are unwilling to increase taxes sufficiently to solve those challenges. Unfortunately as we have seen in Wisconsin and elsewhere, the other option, shrinking government, is a very challenging business.

These sorts of risks have been with us for some time, and we have previously provided scenarios of a new financial crisis. Suffice it to say, that a new financial crisis would cause another serious recession.

After having assumed away, justifiably we think, the most frightening options, we still come up with a soft forecast. It is better than we’ve seen over the past few years, but this recovery is far less robust than most, held back as it is by still-weak financial institutions and real estate markets.

We expect United States economic growth to be positive, but annualized quarterly economic growth rates (GDP) will likely remain well below three percent throughout most of 2011.

We expect job growth will be even weaker, with barely-above-one-percent annualized growth rates. This rate is insufficient to significantly reduce unemployment rates, if labor force participation rates remain unchanged.

However, we’ve seen steadily declining labor force participation, to the lowest level in decades, for several quarters. This is a result of the discouraged worker problem. Millions of Americans have been out of work for extended periods. Eventually, many of these workers just give up and leave the workforce. Those who do not give up face increasingly difficult challenges in finding a job, as human capital deteriorates of becomes obsolete.

Productivity growth continues to impress. In recession or not, United States productivity has shown remarkable strength. The trend has been strong enough to outweigh the cyclical impact for each of the past two recessions.

Productivity growth has been cited by some as a reason for our high unemployment. This cannot be true. The history of the world since the industrial revolution has been one of increasing productivity and increasing jobs. Rather, weakness in jobs is a result of a weak small business sector (see the Economic Activity essay) and structural changes. Some industries face real challenges filling open positions, while millions are unemployed or underemployed. Medical care has continually seen job gains, while millions of construction workers have been displaced. It takes time to turn a construction worker into a healthcare worker.

All this is to say that it looks like the recovery will continue to be soft and fragile. We expect to see job growth, welcome job growth after years of decline, but many challenges remain.

If you are looking for a summary statistic on the United States economy, I recommend you consider bank charge-offs. These are the loans that banks have written off their books, because the probability of collecting them is so low. It doesn’t mean that the borrowers are off the hook, or that the bank will stop trying to collect the loan. It only means that a bank can’t consider a charged-off loan an asset.

Most people use GDP growth as a summary statistic for the economy, which leads to the current situation where policy makers and talking heads have declared a recovery while millions who have been unemployed for months or years continue to be unemployed. Indeed there were two recessions, based on GDP, in the 1960s where all of the job losses occurred after the recession was declared officially over.

OK, so why not use jobs as an indicator of prosperity? Actually, I’m sympathetic to that. It is certainly a better indicator of well being than is GDP. However, I think that charge-offs, particularly now, give us a little more information. Jobs tell us what businesses are doing. Charge-off data tell, at least in some sense, what business can do. That’s because banks don’t lend much when charge-offs are high, and without loans, businesses can’t grow.
So, what are bank charge-off data telling us?

They are telling us that a robust recovery is a ways off. Below is a history of real, inflation adjusted, bank charge-offs:

Prior to 2007, quarterly bank charge-offs had never exceeded $15 billion a quarter in today’s dollars. Then, they skyrocketed to almost $60 billion a quarter. Since then, bank charge-offs have fallen, but they remain well above $40 billion a quarter. You have to conclude that our banking system is still crippled.
This impacts small business much more than it impacts big business. Big businesses have direct access to capital markets and don’t need financial intermediation.

There are more reasons to be bearish on American small business growth. People who own small business own real estate, much more than the typical American. About 98 percent of all small business owners own their own home, but only about 66.5 percent of all American households own their own home. This means that small business was disproportionally hurt by the collapse in real estate values. Their balance sheet was suddenly over-leveraged, impairing their willingness and ability to borrow.

The inability of small business to use real estate equity to finance growth has impacts that are exacerbated by a banking sector that has forgotten how to lend to small business without the use of real estate as a secondary repayment source.

It used to be that small business had access to lines of credit secured by inventories or receivables. These were expensive loans, but they did not require real estate equity for the firm to grow, and in cyclical businesses they were self-liquidating, something that bankers just loved.

As real estate values climbed, banks lowered costs by moving away from these loans. Consequently, while some inventory and receivable financing remains, it is less important than it used to be. Perhaps worse, many bankers don’t know how to make and supervise inventory and receivable lines of credit. It was always a specialty. Today, asset-based lending, as this type of lending is referred to, is an almost forgotten specialty.

Still, those banks that are well enough capitalized to be aggressively seeking lending opportunities would be well advised to consider setting up asset-based lending units. It may be the only way for them to significantly increase loan volume in the near term. It would also be a service to small business and the economic well being of all of us.
The other alternative for small business expansion would be for real estate values to suddenly increase. That is not going to happen in this or next year. I go into the reasons more in the Real Estate Essay, but I have another summary statistic for you, Home Ownership Rates.

Home ownership in the United States is generally about 64 percent. That is about 64 percent of households own the home they live in. When the homeownership rate gets much above 64 percent, we have problems in our financial sector. Remember the Savings and Loan Crisis?

The United States homeownership rate climbed during the second half of the 1990s and the first half of the 2000s, until they peaked at over 69 percent. Since then, it has fallen, but not by enough. Until the United States home ownership ratio drops to below 65 percent, there will be no generalized upward pressure for home prices.

I think we have to conclude that this recovery is weak, because the normal drivers of a robust recovery, small business and real estate, can’t contribute.

Seeing a problem and knowing how to solve it are two different things.  So, we’re going to see lots of silly ideas proposed.  We’ll see demands for more government spending.  We’ll see demands for less government spending.  We’ll see demands for higher taxes.  We’ll see demands for lower taxes.  We’ll see demands for more consumer spending.  We’ll see demands for more consumer saving.

All of these recommendations can’t be correct.  In fact, they are all beside the point.  I’m not saying the proposals won’t have any impact.  They will, but the impacts will either be marginal or they will be some time in the future.  Our problem is immediate and very serious.  Here’s what we need to do to avoid a lost decade:

• Fix the financial sector
• Stop paying interest on deposits at the Fed
• Lower effective borrowing costs with an investment tax credit
• Reduce regulatory uncertainty and big-business bias
• Increase immigration

Any vigorous recovery needs a vigorous financial sector, and ours is not.  Fed policy has been ineffective, because the money multiplier has tanked, even as the monetary base soared.  There are two reasons for this: The Fed is paying banks to deposit at the Fed, and the banks–burdened with over-leveraged balance sheets, huge charge-offs, and bad assets–are in no shape to lend.  Fix the banks, and stop encouraging them to park money in Washington, and we’ll have a start on real recovery.

We have an investment problem; there isn’t any.  That’s because, even at zero, borrowing costs exceed expected returns on investments, and the future regulatory environment is extremely uncertain.  We can’t lower interest rates below zero, but an investment tax credit would effectively lower borrowing costs.  Do that and remove regulatory uncertainty, and our businesses will invest.  While we’re at it, let’s reduce big business’ regulatory advantage.

Finally, we don’t have any problems that couldn’t be fixed by a few million new immigrants.  We’d see an immediate increase in housing demand and construction.  Our inner cities would be renewed.  Our economy would see a burst of creativity, energy, and new business formation.

There is only one problem with DJ.  He doesn’t know squat about economics.  It’s not because I haven’t tried.  He refused to believe what I tried to share from my first economics class back in 69/70.  He’s refused to believe anything about economics that I’ve tried to teach him since.  DJ’s a communist, and he’s darn proud of it too, and he’s probably never going to learn, but I’m going to keep trying.

Which brings us to today’s topic.  DJ posted a link to this Robert Reich blog entry and a taunt on Facebook today.

In the blog, Reich correctly points out that inequality is a growing problem in America today.  Then, he starts getting things wrong, very wrong, basically coming to the conclusion that if we reduced managements’ incomes and increased workers’ incomes all would be well with the world.

I can’t believe that Reich really believes that if we just set a higher minimum wage and instituted a new maximum wage, we’d have prosperity for all.  It is well understood in economics that minimum wages increase unemployment and price ceilings create shortages.  Reich’s policy would cause output to fall, unemployment among lower-wage workers to dramatically increase, and management to move to someplace else, say Singapore or Hong Kong.

Inequality is problem, a serious problem and a growing problem.  The causes are a failed educational system, a completely inadequate safety net, and a lack of commitment to opportunity in far too many communities.

While returns to education have been increasing, our educational system has been declining.  The failure to prepare students for the workforce, particularly those who will not go to college, is paid for by the student.  It is paid for in lower income throughout their work life, and in more frequent and longer-lasting income interruptions.

Educational problems are not limited to k-12.  The rapid increase in the cost of a college degree is strong evidence that colleges and universities have managed to extract a significant portion of the gains to education, often leaving the student with debt that takes years to repay.  Too often that expensive, debt-funded, degree fails to provide the expected income, a result of a degree in a field with little market value or a program that lacked rigor.

The lack of an efficient safety net means that unemployed workers have an incentive to take the first available job offer.  That first job offer may be a perfect match, but it may not be.  The problem  is that without a safety net that would allow time for a search for a better match, or provide for geographic mobility, both  society and the worker are worse off.

Finally, communities limit opportunity in the service of quality of life, failing to recall that for many quality of life begins with opportunity.