Economic Outlook for 2014 – U.S. Economic Fundamentals Should Improve More Rapidly in 2014, But Return to Full Potential Will Take Much Longer
This is an excerpt of the December 2013 Longbrake Letter. To read the letter in its entirety, click here.
It has been four and a half years since the official end of the Great Recession. Following all other recessions since the end of World War II, after four and a half years the economy was operating near or above potential. As we come to the end of 2013, even as there is growing optimism that the U.S. economy will improve more rapidly in 2014, there is still a long ways to go to achieve full potential. This policy objective will not be achieved in 2014 or 2015.
Although U.S. payroll employment rose 2.1 million over the first eleven months of 2013 and is growing at a 1.7 percent annual rate, payroll employment is 1.3 million below and household employment is 2.0 million below the pre-Great Recession peaks reached in January 2008. By comparison, payroll employment four and a half years after the severe 1980-82 double dip recessions was 11 percent above the pre-recession level.
Unemployment during 2013 has fallen from 7.85 percent to 7.02 percent and is closing in on the Congressional Budget Office’s (CBO) full-employment estimate of 5.5 percent. That is the good news. But the official unemployment rate understates the extent of labor market weakness.
For example, the ratio of those employed to those eligible to be employed (employment-to-population ratio) did not improve during 2013. That ratio was .586 at the beginning of the year and remained at .586 in November. What this means is that all the job creation during 2013 has been just sufficient to absorb the natural increase in those eligible for employment. This ratio was .629 at the beginning of the Great Recession. There would be 10.8 million more people employed today, if the employment-to-population ratio had not declined.
What has happened to these 10.8 million people? They fall into four categories: (1) those officially counted as unemployed by the Bureau of labor Statistics (BLS); (2) those who have dropped out of the labor force permanently as a natural result of demographic trends, such as the aging of the baby boom and delayed entry because of pursuit of higher education; (3) those who have exited permanently because their skills no longer meet employer needs (this is referred to as structural unemployment or hysteresis in economist parlance); and (4) discouraged workers, who have employable skills, but simply have given up trying to look for work. Table 1 shows the composition of reduced employment as of November 2013.
According to my statistical analysis, demographic trends are reducing the participation rate by 0.23 percent annually. This is similar to GS’s estimated annual rate of decline of 0.25 percent. This amounts to about 570,000 annually or 3.3 million over the last six years.
What all of this means is that the U.S. economy is simply smaller today than it would have been had the employment-to-population ratio not declined. The issue confronting policymakers is what the employment-to-population ratio would be, if jobs existed for those willing and qualified to work. The number of additional jobs required to return the economy to full employment ranges between 5.22 (4.44 million, if the full employment unemployment rate is 5.5 percent) and 7.44 million, depending upon whether any of the structurally unemployed people could ever expect to become reemployed. The number of jobs needed could be less than 5.22 (or 4.44) million, if some of the discouraged workers actually belong in the structural unemployment category.
Composition of Reduced Household Employment in November 2013 Compared to January 2008 When Unemployment Rate Was 5.0%
|Increase in Number Unemployed as Reported by BLS|
|Assumes a 5.0% unemp. rate; 1.98 for 5.5% unemp. rate|
|Decrease Due to Demographic Trends|
|Increase in Structural Unemployment|
|Residual of other estimates|
|Number of Discouraged Workers|
|9.99 assuming 5.5% unemp. rate|
If the recent rate of growth in employment continues at 1.7 percent, it will take 2.9 years (5.5 percent unemployment rate) to 3.5 years (5.0 percent unemployment rate) to eliminate the employment gap (late-2016 to mid-2017).
Of course, if the pace of employment growth accelerates in 2014 and 2015, the employment gap would close more quickly. There are grounds for optimism that this could occur. Payroll employment has grown at a 1.6 to 1.7 percent rate in each of the last three years in the face of significant negative forces, including housing foreclosures, tax increases, over indebtedness, gyrations in oil prices, and political uncertainty. Most of these factors should be more benign in 2014. In particular, the large tax increases in 2013, which depressed consumer spending, will not be repeated. Stock prices and housing prices are rising. Repair of consumer balance sheets is well advanced. Increasing U.S. energy production and shifting Chinese economic policy carry the promise of stable oil and gas prices. And, perhaps, the unsettling brinksmanship that Congress has engaged in will abate. The recent budget deal is cause for optimism.
We may look back a year from now and see that a virtuous circle finally took hold in 2014. With no further increases in taxes and rising employment, consumer spending should grow faster in 2014. This is the necessary catalyst to inaugurate the virtuous circle. Increased consumer spending will bolster employment growth. Employment growth will lead to even more consumer spending. And, as the employment gap slowly closes, nominal wages should begin to edge up. None of this is likely to occur very quickly but all of these developments should be mutually reinforcing and contribute to steady improvement.