Contact

A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.

News

 

No Recession, but Growth Downshifting


After a June that was decidedly on the sluggish side, economists are dissecting major U.S. data this week to reassure themselves July was different.

They may be disappointed. While it's plausible that the weakness seen in June - in particular in the non-farm payrolls report - may not be duplicated, a growing number of observers say the current debate over whether June was just a detour on the economic high road is missing this point: the U.S. economy is experiencing an inevitable slowdown after a period of robust expansion.

"We're at the cusp of the transition from the accelerating phase of the recovery to the decelerating phase," said Lakshman Achuthan, managing director at the Economic Cycle Research Institute, an organization that analyses and tracks the U.S. and global business cycles.

He points to a host of indicators - including ECRI's proprietary leading indexes - as evidence that gains in the economy this year can't overshadow the structural forces that continue to weigh on key components of it, such as manufacturing.

To a large extent, the fortunes of the manufacturing sector have tracked the trajectory of this economic cycle extremely well. In the long period between the end of the recession in November 2001 and August 2003, job growth was the main missing ingredient in an otherwise healthy economy and nowhere was that more evident than in manufacturing.

The hemorrhaging of jobs from the industry - a net 3.258 million jobs have been lost since the peak of manufacturing in April 1998 - sparked a political outcry and looked set to become a major issue in this year's U.S. presidential elections. Then last fall, the labor market began to show signs of life; a little over 1.5 million jobs in total have been created since then.

Again, manufacturing has been part of the trend. While the Institute for Supply Management's national manufacturing survey for July showed the employment index slowing to 57.3 from 59.7 in June, it's been above the line that differentiates between growth and contraction for nine months now. The headline index of manufacturing activity, at 62.0 in July, has been above 60 for the longest stretch since the 12-month period between July 1972 and June 1973.

That's left the travails of manufacturers less of a rallying cry on the campaign trail, although it's still an election year issue in some of the industrial swing states of the mid-West.

Rose Colored Glasses

Yet Achuthan and others argue the gains seen in manufacturing and elsewhere have acted as blinkers that have blocked out the structural forces that continue to undermine the labor market. The fiscal and monetary stimulus from the government tax cuts and Federal Reserve rate cuts also had a positive effect. "A rising tide will lift all boats, even those that are leaking and manufacturing is leaking," said Achuthan.

To be sure, the ECRI economists don't think the U.S. is heading for a recession.

After growing 4.5% in the first quarter and 3.0% in the second, it's simply reverting back towards its long-term average growth around 3%. But the question is will that be sufficient to create jobs and maintain the momentum of the economy as the forces of globalization and productivity continue to alter its nature?

It also raises doubts about the extent to which the U.S. can close the so-called output gap - the gulf between actual growth and potential growth - that's a key focus of the Fed. "The growth we seem to be slowing to is still fairly robust growth, but it doesn't close the gap quite as quickly," said Erica Groshen, an economist at the Federal Reserve Bank of New York.

Groshen, along with fellow New York Fed economist Simon Potter, generated attention last year for a bleak assessment of the difficulties facing labor markets, arguing in a paper that the reason why the jobs market was having such trouble was structural in nature. All the jobs lost in the recession of 2001 and thereafter were positions that were gone for good, victims of fundamental changes in the economy.

While she's turned a bit more optimistic now, Groshen said she hasn't changed her fundamental view. "So far our conclusions have not been shaken."

Part of the problem centers on the ongoing shift out of manufacturing into more high-skilled areas. "This is really a matter of managing the right allocation of resources," said Groshen. "If we don't need our people as much to work in manufacturing, the challenge is to find the best use of our resources to do something else."

Underscoring that, a recent ECRI report blamed the duration of joblessness for much of the general anxiety about the labor market and said the problem was rooted in these structural changes. "Those that are unemployed have been unemployed for a very long time," said Achuthan.

The risk inherent in that - and one no doubt very much on the minds of those in the Bush administration - is that perceptions of how the economy is doing continue to slip heading towards the November elections, fueling an existing sense that regardless of growth signs, it doesn't feel like the labor market's doing well.