A JOB - RICH U.S. RECOVERY IS STILL PLAUSIBLE / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( RECOMMENDED READING )

A job-rich US recovery is still plausible

By Robert Barbera and Charles Weise

Published: January 10 2010 19:15

Only one short year ago, the world was staring depression in the face. Now the economy is recovering, but many commentators are warning of a “jobless recovery” of the kind that followed the last two recessions, in 1990-91 and 2001.

Most recently, on January 3 at the American Economic Association annual meeting, Don Kohn, US Federal Reserve vice-chairman, warned that employment growth in 2010 would most likely be slow. Thus the conventional wisdom now has it that the message embedded in Friday’s December US jobs report – a seeming end to firing but little evidence of net new hiring – will turn out to be a precursor to similar news on jobs that will dominate throughout 2010.

We believe that these meagre expectations will turn out to be wrong, in large part because they mischaracterise how employment has swooned over the past two years.

The scenario of a jobless recovery is founded on two propositions. First, that the crisis has left a damaged economy incapable of generating robust growth in demand. Second, that many employers responded to the recession by permanently restructuring their businesses and, in so doing, irrevocably reducing their payrolls.

To be sure, managers cut payrolls much more drastically than they normally do during a recession. As a consequence, job losses were disproportionate to the decline in output. Correspondingly, productivity grew at an impressive rate in 2009.

It is generally held that these dynamics amount to a structural change in the labour market, one that ensures healthy job growth will not return soon. Our more optimistic outlook is based on a different theory of why payrolls were cut so aggressively. Because of the turmoil in financial markets in autumn 2008, companies faced a severe cash crunch. As a result, they attempted to hoard cash in any way they could: they slashed order books, ran down inventories at an unprecedented pace and cut short-term borrowing. And they slashed payrolls. The drastic reduction in inventories and payrolls was not, in other words, a result of restructuring: it was symptomatic of panic, the same panic that caused the massive sell-off in equities, corporate bonds and mortgage-backed securities.

The very good news, for the US and the globe, is that policymakers succeeded in reversing the panic selling of risky assets. As order was restored to financial markets, the prices of most risky assets recovered dramatically from their fire-sale levels. Similarly, as order is restored to the real economy, inventories and payrolls should revert to normal levels, setting the foundation for a solid recovery.

The government rescue of the financial system worked impressively. As of this writing the risk premium that investors require for accepting the risk of corporate default has fallen to 250 basis points, only 70 points above its 20-year average. Likewise, commercial paper rates are near neutral versus Treasury bill rates and incredibly low on an absolute basis. Stocks have recouped more than half of their losses and junk bond borrowers now face interest rates near all-time lows, compared with near 20 per cent rates one year ago.

Nearly all projections for the US economy envision a sharp reversal for inventories in the coming quarters. We argue that the recovery in jobs should mirror the restocking of inventories because the collapse in employment and inventories during the recession had the same source in panic-driven cash hoarding. A restoration of unemployment to levels consistent with the decline in output the US economy has experienced would bring the unemployment rate down to around 9 percent. If GDP grows at a 3.8 per cent rate in 2010 – a better-than-consensus forecast but still tame relative to history – the unemployment rate at the end of 2010 could be closer to 8.5 per cent.

The same logic can be applied to productivity. Using consensus expectations for current-quarter real GDP we estimate that the last three quarters of 2009 registered an average rate of advance in labour productivity of almost 7 per cent. We estimate that productivity is now above its normal level, so reversion to the mean over the next year implies a productivity growth rate substantially below trend.

The following scenario then appears quite plausible. Real GDP grows at a rate of 3.8 per cent in 2010, with productivity growth of 0.7 per cent and a modest increase in average weekly hours. In such a world, employment growth would average 2.2 per cent. This translates to an average of about 240,000 jobs per month.

This scenario, while wildly optimistic compared with current consensus forecasts, amounts to a weak recovery by historical standards. In the first full year of recovery after the 1981-82 recession, GDP growth was more than 7 per cent. Following the recession of 1974-75, growth was 6 per cent. It is not hard to imagine growth over the next year well in excess of our 3.8 per cent forecast, with jobs growth in the 300,000 per month range. We are not endorsing that as our forecast but we believe it is as likely as the jobless recovery predictions that define the conventional wisdom.

Barack Obama therefore needs to be patient. A modest fiscal stimulus focused on aid to the states would be a helpful insurance policy against a further weakening in the economy. But the trends are in the administration’s favour, and a major new stimulus program should be resisted. The president is known to be deliberative. Let us hope he waits for the better news to arrive.

Robert Barbera is chief economist, investment technology group, and economics department fellow at the Johns Hopkins University. Charles Weise is chairman and associate professor of economics at Gettysburg College

Copyright The Financial Times Limited 2010.