Outlook: Mixed Economic Data

The Outlook: Mixed Economic Data Show A Changing Business Cycle

By Jon Hilsenrath and Kelly Evans, WSJ | 8 September 2008

The U.S. economy looks like it is traveling along two tracks.

If you look at output— the amount of goods and services Americans produce— the economy has been rising at a decent clip. But people aren't feeling it in their wallets because the factors driving their own incomes— such as jobs and wages— are under strain. The point has been underscored by a slew of economic reports released in the past few weeks. The government's measure of inflation-adjusted gross domestic product expanded at a surprisingly robust 3.3% annual rate in the second quarter. Exports were a big driver, in particular exports of industrial supplies and capital goods.

Yet employment has fallen for eight straight months by a cumulative 605,000 jobs. More than half of the losses have been in manufacturing. You might expect manufacturing employment to hold up better during an export boom. But it isn't. With job losses mounting, companies are cutting back on hours and getting tough on wages. Year-to-year personal income growth has slowed from more than 7% a couple of years ago to a little more than 4% in July, not enough to keep up with inflation.

In theory, output and income should go up and down together. If the economy is still expanding, why are so many households being squeezed? One answer is that the business cycle itself is changing. Recessions in the past used to follow a predictable script. Business would slow or inventories would go up too much and catch companies flat-footed. As their own productivity dropped, they would belatedly respond by cutting back on workers. Then, as the process fed on itself, everything would go down together— output, employment, income and productivity.

The 2001 recession changed the script— productivity held up surprisingly well throughout. Companies cut back ahead of the business slowdown and kept doing it even after demand started rising again. The productivity they managed to squeeze out of existing workers bolstered output, even as it strained households. The same thing seems to be happening again: To the surprise of many economists, worker productivity is rising, not falling.

"There seems to be a change in how businesses operate," says Dean Maki, economist for Barclays Capital. With better technology, businesses get ahead of inventory buildups or demand slowdowns more quickly. The declining influence of unions is also putting management in a position to fire workers more quickly.

AP; A customer holds his wallet as he pumps gas at a Shell gas station in Menlo Park, Calif.

The result: While incomes are getting squeezed, the output per hour of workers was up at an annual rate of more than 3% in the first half of the year. More than ever, it seems, this puts the brunt of a downturn on workers. But there are important upsides to the shift. Better productivity helps bolster corporate profits, so while the stock market is weak it hasn't collapsed as have stock markets elsewhere in the world this year. It also helps restrain inflation and give the Federal Reserve leeway to keep interest rates low and help the economy heal.

It also makes it harder to read a business cycle. The collection of economists at the National Bureau of Economic Research who date recessions debated for months about the beginning and end of the last downturn because of the striking disconnect between output and income. "If you dated it based on the labor market you'd have it be one of the longest recessions in history, and that didn't feel right," says Christina Romer, an economics professor at the University of California, Berkeley. The group finally decided November 2001— when output growth restarted— was the point at which the recession ended, making the eight-month slowdown one of the shortest on record.

But the debate hasn't gone away. "What matters to individuals more than anything else is the behavior of the labor market," says John Lonski, chief economist at Moody's Investor Service. "If I were the NBER I would simplify the entire process and focus on the labor market. From the perspective of the economy and social welfare it's labor-market behavior that matters the most." There are other factors at play now, including confusion about how statisticians measure all of these trends. Some economists are skeptical of the 3.3% annualized increase in gross-domestic-product growth registered in the second quarter. The figure, produced by the government's Bureau of Economic Analysis, is out of line with another BEA figure called gross domestic income— a measure of the income earned by businesses and households.

In theory, the two figures should go up and down together. But gross domestic income expanded at a much smaller 1.9% annual rate in the second quarter, after contracting the two previous quarters. The income number might have been skewed as government statisticians try to make sense of the massive write-offs being recorded by banks. The output number might also have been skewed, for instance by big shifts in the trade environment and the price of oil. Data revisions could ultimately show output wasn't as strong as it now appears.

Statistics aside, it is also possible output won't hold up under the pressures building against the U.S. economy, even with better productivity. Exports have been the bright light in the growth picture. But the global economy is slowing. Neil Soss, a Credit Suisse economist, notes that three quarters of the economy's growth in the past year came from an improved trade position. "How much can I count on that for the future?" he asks.

Meantime, the strain on incomes might finally be catching up to households. They will clearly be helped by the drop in gasoline prices, but tax rebates have run their course and the housing and credit squeezes run unabated. Adjusted for inflation, consumer spending— the biggest driving force of growth— contracted in June and July. It hasn't contracted for an entire quarter since late 1991. That 17-year run is now being put to the test. If consumers crack, output and income might finally meet up again— in recession.

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Normxxx    
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