Labor Day Highlights the Need for American Restructuring

The world has changed!

Of course, entrenched interests fight the change.

An instance is the United States Postal Service:  we heard over the weekend that the Post Office faces the possibility of bankruptcy.

The high profile cause of this situation: email.

The cause that gets a lesser play is the position of the labor unions connected with the Postal Service.  The Postal Service is the nation's second-largest civilian employer, after Wal-Mart. As of 2011, it employed 574,000 personnel, divided into offices, processing centers, and actual post offices.  The employed are served by four major labor unions, the National Association of Letter Carriers being the largest. 
 
Offices have continued to be kept in existence in spite of declines in business and expenses, including wage and pension costs, have continued to grow relative to the services provided.  Now however, cuts are being proposed: proposed cuts include eliminating Saturday mail delivery, closing up to 3,700 postal locations and laying off 120,000 workers — nearly one-fifth of the agency’s work force — despite a no-layoffs clause in the unions’ contracts.  

In terms of the labor situation, Steven Greenhouse writes in the New York Times that “decades of contractual promises made to unionized workers, including no-layoff clauses, are increasing the post office’s costs. Labor represents 80 percent of the agency’s expenses, compared with 53 percent at United Parcel Service and 32 percent at FedEx, its two biggest private competitors. Postal workers also receive more generous health benefits than most other federal employees.” (http://www.nytimes.com/2011/09/05/business/in-internet-age-postal-service-struggles-to-stay-solvent-and-relevant.html?pagewanted=1&_r=1)

There are, of course, many different plans that are being floated around relating to what can be done to “save” the post office.  But these plans all point to one thing…the U. S. Postal Service must be restructured.  It cannot go on as it has been going on.

Resistance is expected: “The post office’s powerful unions are angry and alarmed about the planned layoffs. “We’re going to fight this and we’re going to fight it hard,” said Cliff Guffey, president of the American Postal Workers Union.”

This is just one high-profile example of what is going on all over America. 

The world has changed.

Entrenched interests reject the fact that they must change as well.

Let me just point out three major changes that are impacting the work force these days which have, I believe, massive implications for the future re-structuring of the United States economy.

First, the majority of labor unions no longer reside in the manufacturing sector.  Most employees that belong to labor unions work in the public sector.  The public sector, as we know, has vastly over extended itself, fiscally, in many areas of the country.  The existing economic problems connected with slow economic growth, high rates of under-employment, and a depressed real estate market have put government finances in these areas in bad straits.  Existing relationships are being re-worked as these governments try to get themselves back in control of uthe situation.

The relative growth rates in manufacturing employment dropped off beginning in the 1970s, and now growth in the public sector is seemingly dropping off.  This is a re-structuring problem.

Second, there has been a demographic shift in the workforce.  As reported in ‘The Slow Disappearance of the American Working Man,” (Bloomberg Businessweek, August 29—September 4, 2011) “The (economic) downturn has driven the share of men who have jobs lower than any time since World War II.”

“The economic downturn exacerbated forces that have long been undermining men in the workplace,” and “the impact has been greatest on moderately skilled men, especially those without a college education,” and African-American men and Hispanic men. 

This is another re-structuring problem related to the changes in technology and the changes that have taken place in education: “college graduation rates essentially stopped growing for men in the late 1970s,” whereas “women continued to pursue college degrees in greater numbers and have been more responsive to the changing economy in other ways.”

Third, the last fifty years has also seen a tremendous shift in American employment from the manufacturing sector to the financial sector.  The credit inflation created by the United States government has underwritten the finance industry and resulted not only in growing institutions but also in more and more innovation leading to the greater horizontal diversification of financial institutions.

The example of this is four of our large commercial banks: GE Capital, Goldman Sachs, Morgan Stanley, and ALLY (formerly GMAC).    GE Capital has $606 billion in assets and is bigger than all but seven U. S. banks.  It now finds itself regulated by the Federal Reserve where the Office of Thrift Supervision formerly regulated it.  But more, important is that GE Capital recently provided 40 percent of the profits of its parent company General Electric.  (Before the financial collapse, the contribution of GE Capital reached 75 percent of GE earnings.)   This shows how manufacturing has given way to finance in the United States.

The re-structuring of the American economy is going to have to take place over the next ten years or so.  This “fix” cannot be achieved through short-run solutions. 

In fact, short-run solutions will only exacerbate the situation.  This, of course, is what most of the economic policy of the last fifty years has done for the United States economy.  The credit inflation of this period has built up the financial sector of the economy relative to the manufacturing sector.  The credit inflation has also supported the growth of the public sectors as the inflation in real estate prices supported the government tax base and open capital markets allowed even small governmental units to expand their expenditures.  Finally, much of the economic policy of the government during this fifty years was aimed at putting people back into the jobs they had lost during periods of slow economic growth.  This “Keynesian” approach to the government’s economic policy had an unfortunate impact on male employment, especially those with a lesser education, because the jobs these people were put back into were jobs that were becoming less and less important in the economy.

The times have changed.  Employment practices must change to meet the needs of the modern world. 

Re-structuring is never easy and we can expect a lot of pain in the process.     

The Problems of Recovery

Comparisons abound between the Great Depression of the 1930s and the Great Recession of the 2000s. So far, we seem to have avoided the depths that were reached in the earlier experience, but we still have to consider whether or not the breadth of the two might be similar. That is, almost everyone one forecasting the recovery of the United States economy in the 2010s seems to be expecting that it will be a long, slow process.

The comparison I would like to consider in this post is the possibility that both of these periods represent a time in which the United States economy was going through a substantial structural change. Many people that have studied the 1930s period argue that the economy that existed in the United States in the 1950s was substantially different from the one that existed in the 1920s. Huge shifts took place in both manufacturing and agriculture throughout the 1930s and these shifts were just accelerated in the 1940s, a period of world war. The underlying cause of this change: technology had changed and the American economy had to adjust to become a modern nation. However, the mismanagement of the financial crisis in the 1930s just exacerbated the depth of the decline.

The argument can be made that major structural changes had to take place in the United States economy as it entered the 21st century. Changes of the magnitude of the present adjustment did not take place during the shorter, less severe recessions of the post-World War II period because the buildup of technological change takes time in order to build up a sufficient backlog of the new technology to really be disruptive. By the end of the 1990s, the structural change connected with the move from a society based upon manufacturing to an information society was ready to occur.

This buildup was not really a sudden one. It has been occurring throughout the last fifty years or so. I believe that the decline in the figures on capacity utilization for the United States captures this change very well.

Note in the accompanying chart that capacity utilization continues to decline throughout the whole period since the late 1960s. Obviously, cycles in this measure took place that were related to the various recessions occurring during the time span, but each new peak in capacity utilization never exceeds the peak it had reached in the previous cycle.

This, I believe, captures the changing nature of the United States economy and the movement from the foundational base of the Manufacturing Age to the growing impact of information technology and the Information Age. The conclusion that can be drawn from this is that the United States economy is not going back to where it was. But, this will take time.

Let me just point out three important factors that are playing a huge role in this change: evolving technologies, changing structure of the labor market, and the rise of the emerging nations.

First, the core of American commerce is not going to be manufacturing as we have known it. The future belongs to information technology, biotechnology, and knowledge. For the government to attempt to “force” workers back into jobs they held in the manufacturing world is just going to postpone the changes that WILL take place and threatens the stability of the society by re-establishing the inflationary environment of the last fifty years.

Second, the age of the labor union is past: non-public sector labor unions are legacy. There was a time when labor unions were needed to temper the pressures and demands of the industrial age of the large corporation who needed large numbers of physical laborers. These unions now compose less than half the union population in America yet have an over-sized impact on the politics of the country. In the next fifty years, the importance of the labor union is going to decline, economically and politically, as the United States moves from the manufacturing base that has dominated the last fifty years into the Information Age described in the previous paragraph.

Third, the United States, although it will remain the number one economic and military power in the world, is going to see its relative position in the world decline. The reason is that major emerging nations are beginning to feel their power and exert it. The immediate group of nations that come to mind are the BRICs. But, there are others. China, as we well know, is starting to exert its influence throughout the world. We see Brazil directly challenge America in the World Trade Organization concerning tariffs and subsidies. (See “Tax Move by Brazil Risks US Trade War”: http://www.ft.com/cms/s/0/dbf4284c-2afa-11df-886b-00144feabdc0.html.) And, more of this is to come! This is going to provide its own pressure for the economic structure of the United States to change.

These adjustments are going to take time. There will be substantial pain for those of working age who are not trained or educated for the new era. I believe that even the number of underemployed, 16%-17% of the work force, under-estimates the structural problem that exists. Thus, the estimate of 11 million new jobs that are now needed in the economy to get us back to where we were before the Great Recession began also under-states the problem.

Investment-wise, just as in the 1950s, the whole structure of opportunities available is changing from the earlier age. But, one needs to consider the new format of the economy that is evolving out of the manufacturing age in developing ones portfolio strategy. Similar to the 1930s, the 2000s are producing a modernization of the United States that will alter the world as it has been known and will produce a world that we can’t even hardly imagine yet.

It's the Mood of the Workers, Stupid!

Robert Shiller of “Irrational Exuberance” has given us the answer to our problems in the Sunday New York Times. See “Stuck in Neutral? Reset the Mood!” http://www.nytimes.com/2010/01/31/business/economy/31view.html?scp=1&sq=robert%20shiller&st=cse. Shiller argues that, “In reality, business recessions are caused by a curious mix of rational and irrational behavior. Negative feedback cycles, in which pessimism inhibits economic activity, are hard to stop and can stretch the financial system past its breaking point.”

“Solutions for the economy must address not only the structural instability of our financial institutions, but also these problems in the hearts and minds of workers and investors—problems that may otherwise persist for many years.”

The solution: people must believe in the cause! “Reset the Mood!” “In most civilian fields, job satisfaction may not be a life-or-death matter, but a relatively uninterested, insecure work force is unlikely to bring about a vigorous recovery.”

But, the problem goes beyond the current malaise. Shiller advises us to look at the whole post-World War II period. He cites data from the Bureau of Labor Statistics and states that the annual growth of business output per labor hour averaged 3.2% from 1948 to 1973. From 1973 to 2008 the growth rate was 1.9%. He quotes Samuel Bowles of the Santa Fe Institute who has argued that the causes of this slowdown “are to be found as much in the loss of ‘hearts and minds’ of workers and investors as in the technology.”

A cause of this “loss of ‘hearts and minds’ of workers and investors” is not presented. Let me provide a possible cause: inflation!

Since January 1961 through 2009, the purchasing power of $1.00 has declined by about 85%, depending upon the price index used. That is, a $1.00 that could purchase $1.00 when John Kennedy became president could only purchase around $0.15 in 2009.

The “guns and butter” expenditure pattern of the federal government in the 1960s resulted in the wage and price freeze that came about in August 1971 along with the separation of the United States dollar from gold. The excessive inflation of the latter part of the 1970s resulted in the Federal Reserve tightening of monetary policy which finally broke the back of inflation in the early 1980s. Yet, even though the United States went through a period of moderate price inflation during the next twenty years or so (the Great Moderation) credit inflation continued. (For a review of what I mean by credit inflation see http://seekingalpha.com/article/184475-financial-regulation-in-the-information-age-part-c.)

This period of inflation had two major impacts on the United States economy. First, American manufacturers worried less about productivity than they did about getting products to market. Inflation does this to producers. Why? Because the pressure is on manufacturers to quickly get in new equipment so that they can meet the rising demand for goods and this means that executives focus less on the longer-lived, more productive plant and equipment and give their attention to more short-lived investments. As a consequence, productivity suffers!

The impact of this change in the composition of the capital stock of the United States is reflected in two other measures. First, capital utilization in manufacturing industry has continued to decline from the 1960s to the present time. (See chart: http://research.stlouisfed.org/fred2/series/TCU?cid=3.) For example, capacity utilization was above 90% in the middle of the 1960s. Through all the cycles in capacity utilization over the next 45 years, the peak rate constantly declined. In February 1973 the rate was slightly below 89%. The next peak was in December 1978 and was below 87%; then about 85% in January 1989; and again in January 1995 and in November 1997. The next peak came in August 2006 at about 81%. The most recent trough in capacity utilization came in June 2009 and has rebounded to 72% in December 2009. Expectations: it will not reach 81% again.

In addition, labor force participation has changed dramatically during this time period. Labor force participation increased substantially from the latter part of the 1960s until the latter part of the 1980s, primarily due to more women taking part in the measured labor force. Since the late 1980s the growth of total labor force participation began to slow down and in the 200s total labor force participation began to decline as more and more people became discouraged in looking for a job or only could find temporary employment. In 2009 the number of under-employed individuals of working age amounted to between 17%-18% of the labor force. Thus, we have unused capacity in the labor force as well.

The second major impact this period of inflation had on the United States economy was on the use and creation of debt. Inflation is good for debt creation! But, the foundation for the increase in debt during this time was the Federal Government, as the gross federal debt increased at an annual rate of 7.85% per year for the period of time from fiscal 1961 through fiscal 2009. The federal debt held by the public rose by 7.31% over the same time period.

Private debt, of course, increased very, very rapidly during this time period as did the financial innovation that spread debt further and further through the economy. Inflation is good for debt and it is also good for employment in the area of finance and financial services. As is well known there was a tremendous shift in the work force during this time from non-financial firms to financial firms. Furthermore, labor productivity does not increase as much annually in the finance industry as it does in non-finance.

Why should the labor force put its “hearts and minds” behind the future of the United States economic machine?

One sees no end to the environment of “credit inflation” created by the federal government. Estimates of federal government budget deficits still range in the $15-$18 trillion range for the next ten years which would more than double the gross federal debt that now exists. Then there are questions relating to the Federal Reserve’s inflation of the monetary base and the possibility that the central bank can pull off a magical “exit” strategy where the Fed removes roughly $1.1 trillion “excess” reserves from the banking system without causing any disruptions. The eminent scholar of the Federal Reserve System, Allan Meltzer, seems to have serious doubts about the Fed being able to pull this off. (See http://online.wsj.com/article/SB20001424052748704375604575023632319560448.html#mod=todays_us_opinion.) The failure to succeed here, along with the rise in the federal debt, would just further underwrite credit inflation in the whole economy.

The international investment community continues to have concerns over the ability of the United States to do anything different from what it has done over the last 50 years or so. There is nothing to indicate anything more than “business as usual” in Washington, D. C. If this is true, then we will see continuing credit inflation, sluggish performance in labor productivity, continued declines in labor force participation, and further softness in capacity utilization. And, if the environment of credit inflation continues, finance and financial innovation will continue to thrive.

We don’t need a change in the “hearts and minds” of the labor force. The change in “hearts and minds” that is needed is in the politicians in the federal government.

A Walk on the Supply Side

Keynesian demand-side economics still rules the minds of the policy makers in Washington, D. C. Their actions and their analysis continually point to their focus on aggregate demand and the “green shoots” that are expected to accompany an economic recovery based on the stimulus of spending.

For over a year I have been arguing that more attention needs to be given to the supply side of the equation. Yes, the growth rate of real GDP has been going down and the rate of employment has been going up. But, the rate of inflation, as measured by the rate of increase of the GDP price deflator has not declined since the fourth quarter of 2007. If it were just a demand side problem, this would not be the case.

I focus on the rate of increase in the GDP implicit deflator because of some of the measurement problems associated with the Consumer Price Index, such as the treatment of housing expenses and energy. Certainly, the CPI should be watched, but in dealing with economic aggregates, I prefer the former.

My point has been that if the problems in the economy were all tied to a substantial fall in aggregate demand, then there should have been a more substantial lessening in the rate of price increases. Consequently, my argument has been that something has happened on the supply side of the economy for the numbers to have been reported as they have been.

I would like to point to two areas of the United States economy that indicates that the problems of recovery may be more difficult to overcome than if the dislocation in the economy were just one of inadequate aggregate demand. The first area is that of industrial output; the second area is the labor market.

In terms of the industrial base of the economy I would like to focus upon industrial production and the industrial utilization of capacity. Industrial production has been declining steadily since the start of the recession in December 2007. At that time, industrial production was growing at about a 2.0% year-over-year rate of growth. By April 2008 the year-over-year rate of growth had become negative. The figures for 2009 are
January -10.8
February -11.3
March -12.6
April -12.7
May -13.4

This certainly shows a continuing weakening in the economy. However, taken by itself I don’t think that it carries more meaning than does the decline in the rate of growth of real GDP which has been declining as well.

Combine this performance with the figures on capacity utilization and one gets a different picture. As expected, total industry capacity utilization has dropped substantially in this recession. In December 2007, the figure stood at a little over 80.0%. In May 2009, capacity utilization had fallen to about 68.0%. This is the largest 18 month decline in the post-World War II period.

But, this is not all. The peak in capacity utilization in the past ten years was only slightly more than the December 2007 figure. But, this peak of the last ten years was substantially below the level of capacity utilization for most of the 1990s which was below the peak utilization in the 1970s which was below the peak utilization in the 1960s. That is, it appears as if we have been using less and less of our capacity on a regular basis since the 1960s.

The structure of our industrial base is changing. We can see that in autos, in steel, and in many other parts of our manufacturing base. It appears as if the weakness in our economy is composed of two things: first the cyclical swing in business; but this weakness is on top of a secular decline in our productive ability. The economy is in the process of restructuring!

This shift is also showing up in labor markets. The civilian participation rate in the labor force for the United States rose from the late 1960s into the 1990s when it peaked a little above 67.0%. The civilian participation rate has declined since late 2000 and has remained below 66.2% since 2004. In terms of the number of people who are not participating in the labor market any more, this represents a large number. People have left the labor force in the last five or six years and this trend has, of course, been exacerbated by the recession. Over the past forty years the rise in the participation rate has slowed down or stopped during recessions, but at no time did it decline as it did in the in the past six years.

Of further interest, the Labor Department reported that separations from jobs in April remained relatively constant as they have for the past two years, but the rate of hiring continued to be quite low. In early 2008 the percentage of the labor force that were separated from their jobs was about equal to the percentage that were being hired. Since then separations have exceeded hirings, as might be expected, causing the unemployment rate to rise.

In terms of those that were separated from their jobs, there was a dramatic shift between those that quit their jobs and those that were laid off or discharged from their jobs. The percentage of layoffs and discharges rose dramatically from April 2008 to April 2009 whereas quit levels dropped substantially. That is, although separation rates did not change much at all during this time, the composition of those being separated from their positions experienced a tremendous shift. This is an indication that there is a structural shift in what is happening in the labor markets.

This information leads me to believe that there is a substantial restructuring taking place in the United States economy. And, a structural shift is a supply side issue and not a demand side issue. In fact, demand side responses can just make a bad situation worse by trying to force people back into positions that companies and industries are attempting to eliminate because the world has changed.

The figures on industrial production and capacity utilization seem to indicate that industry is changing and the numbers from the labor market reinforce that conclusion. Pumping up aggregate demand is an attempt to stop this restructuring or, at least, slow it down.

The problem that policymakers’ face is that they, or we, do not know what the new industrial structure is going to look like. It is impossible for anyone to know. People can make guesses, but that is all they are—guesses. And, in situations like this, it is more likely that the guesses will be wrong rather than being right. It’s just that the future is unknown. The need for the United States economy to restructure just adds another “unknown, unknown” to our list of “known unknowns” and “unknown, unknowns.” My guess is that this restructuring is going to take some time and could be sidetracked by huge government deficits and a supportive monetary policy.