Friday, October 2, 2009

September Employment Report: A Few Thoughts

The disappointing employment report- with its 263K decline in September, the small net downward revision to the prior two months' declines, the drop in the labor force participation rate to 65.2% and the dip of the workweek to its cycle-low of 33.0 hours- highlights starkly the obstacles that the fledgling recovery is facing. An uncharacteristically big decline in government jobs last month (-53K versus a long-term trend of an average monthly gain of 10K to 20K) can only serve as a partial explanation for the magnitude of the drop in total payrolls. It was, after all, the sizable declines in manufacturing, construction and service jobs together that accounted for the lion's share of the overall drop.

Since the start of the recession in December, payroll employment has eroded by 7.2 million and, given the current trajectory of hiring, it is quite possible that it will reach the 8 million mark by the time the monthly numbers start turning positive. Still, that seemingly bleak prospect should not be allowed to disguise the key reality that the employment picture has improved markedly in recent months, taking the form of a much slower pace of job erosion. In the third quarter, the average monthly payroll decline was "only" 256K compared to 426K in Q2 and 691K in Q1.

Despite the generally dispiriting tone of today's employment data, it is important not to lose sight of the critical distinction between payroll growth and GDP growth in the next few quarters; the former is not a prerequisite for the latter to occur- at least not for a while. The cyclical rise in productivity that occurs in the early stage of an economic recovery (the result of employers utilizing their existing labor force more intensively at first before they resume hiring more confidently) should be adequate to generate positive GDP growth in the second half of the year and into early 2010. This, provided that hiring will catch up with, and possibly exceed by early 2010, layoffs (therefore, generating positive payroll numbers), should allow for the economic recovery to make a smooth transition into a respectable economic expansion.

There is also an additional factor that allows for that at least temporary disconnect between employment growth and GDP growth to exist. GDP numbers are, after all, a bean-counting exercise; the arithmetic of the whole thing can often play unexpected games. The massive pace of inventory depletion in the first half of the year subtracted an average of nearly two percentage points from real GDP growth in the first two quarters of the year. With inventories having now been much better aligned with sales, they are likely to be an essentially neutral factor for GDP purposes in the second half of the year and early 2010, therefore removing a potent drag on the numerical aspect of economic growth.

Ultimately, a credible economic recovery cannot take hold without payroll employment picking up. But the latter condition is not a necessity for the time being.