What is the True State of the U.S. Labor Market?

Last Friday’s employment report for the month of December caught most people by surprise. While the unemployment rate fell to a post-crisis low of 6.7%, the preponderance of the data released suggest that the labor market remains in a weak state. First, the Labor Department reported that just 74,000 new jobs were created in December – well below the consensus estimate of nearly 200,000 and below the average monthly gain of 192,000 from January through November. It is true that inclement weather played a role in the weak job creation, but it’s hard to pin all the blame on Mother Nature. December’s disappointing job growth is emblematic of the weakest jobs recovery we have seen in the past 50 years.

Secondly, the labor participation rate fell yet again to a multi-decade low of 62.8%. In fact, the weakness in labor participation explains the improvement in the unemployment rate. As people drop out of the labor force out of frustration, they are removed from both the numerator and denominator in the calculation of the unemployment rate. This causes the unemployment rate to decline, albeit temporarily (perhaps). Ironically, most economists believe there will initially be upward pressure on the unemployment rate when the labor situation improves materially. This is because those frustrated individuals who had quit looking for work (and were therefore removed from the labor force) will re-enter the labor force and be counted as “unemployed” again until they find jobs.

Another persistent weakness in the labor data is the number of people who are working “part-time for economic reasons.” These individuals, who total about 7.8 million or about 5% of the labor force, represent folks who would rather be working full-time but were only able to find part-time jobs. The new health care legislation may be playing a role in the high number of part-timers. But whatever the cause, the high number of people working part-time for economic reasons probably leads to an understatement of the true rate of unemployment. Incidentally, those workers employed part-time for economic reasons are included in the Labor Department’s U-6 unemployment rate (also known as the “underemployment rate”), which remains at a stubbornly high 13.1%.

We should also point out that the number of unemployed people in the labor force who have been unemployed for more than 27 weeks remains a stubbornly high 37.5% of the total unemployed population. Why is this important? Economists will tell you that folks who have not worked for an extended period tend to lose skill sets, thereby making it harder for them to ultimately find work. Moreover, a large chunk of the long-term unemployed will eventually be at risk of losing unemployment benefits, which poses additional risks to the economy.

But perhaps the biggest recent drag on the economy has not been the number of unemployed (which admittedly has been shrinking) but the weakness in income growth. Persistently weak middle-class income and wage growth has been a scourge on the economy for many years. The US Census Bureau tells us that in 2012, real median household income (ie, adjusted for inflation) was at its lowest level since 1995. Meanwhile, average hourly earnings (also adjusted for inflation) are lower now than when the recovery started in mid-2009.

Unfortunately, there is no quick fix for the weakness in middle-class income growth. Transfer payments, other than those required for sustenance, are unlikely to provide anything other than a temporary solution. And as long as there is a large amount of slack in the labor market, incomes are unlikely to rise meaningfully. This problem is one of the key reasons why we see continued modest economic growth for a few more years. The unbalanced nature of the recovery remains highly problematic. The gains we are seeing in the economy are being overwhelmingly driven by the wealthiest of our citizens, who are responsible for the lion’s share of the income, wealth and spending increases we have seen. In our view, we will not reach “escape velocity” unless and until the middle class claims more proportional benefits from the recovery.

Peace,

Michael