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Economics:Where Are the Jobs?
New York: March 14, 2005
By John R. Stephenson


"It's tough to make predictions, especially about the future."

--Yogi Berra

Every month it's the same thing. Economists predict that the economy is growing and that this month's Employment Report will show a healthy pick-up in job creation. When the monthly number is released, it is more often than not - a disappointment. A healthy pick-up in hiring would go a long way to replacing the 2.4 million jobs lost since March of 2001, as well as compensating for the 1.2% annual population growth (137,000 jobs/month necessary just for population growth alone). But for some reason, the employment prognosticators with their overly optimistic predictions have been proven wrong, longer and by a greater amount, than at any other time in modern history.

But why is this so? Why is it that the nation's economists with their elaborate forecasting models have done such a dismal job of predicting the state of the economy and the prospects for employment? Has something fundamental in the economy or the business cycle changed? Without doubt, the increase in worker productivity and the rise of outsourcing have had significant negative effects on hiring, but do these two factors alone explain why the 2001-2005 post recession hiring has significantly lagged behind those of previous economic recoveries ?

For sure, the outsourcing of jobs has been a major factor in the sluggish employment growth we are witnessing. The information technology revolution has made it possible for work to be done anywhere in the globe and shipped back to North America with just a click of a mouse. With millions of highly educated underemployed people throughout the world willing to work for a fraction of the cost of the average American, is it any wonder that companies are sending your job overseas? But while it is easy to blame outsourcing for the sluggish job growth at home, there are many reasons why hiring has been so anemic.

The stock market bubble of the 1990's helped to create huge pools of investment capital, which companies used to create productive capacity. But with the bursting of the stock market bubble and with the resultant economic slowdown, a lot of this productive capacity is sitting idle, as demand has not materialized. No matter how you slice it, excess productive capacity makes it hard for the economy to absorb the slack in the labor market. Investments in productive capacity have been driven not only by the stock market boom of the 1990's but also by the accounting treatment of capital spending (accelerated depreciation). In a manufacturing oriented economy, a policy that encourages companies to invest in capital equipment (spending) by buying equipment such as drill presses and oil rigs makes sense as it creates jobs (workers are needed to manufacture and operate the drill press, etc.), but as we have moved away from a manufacturing oriented economy and towards an information economy, a tax policy that allows for the accelerated depreciation of capital expenditures makes less sense. For starters, while iPods and PCs may be designed here, they are manufactured abroad. With tax legislation that favors capital purchases (by providing an economic benefit) over hiring (no tax credits exist for hiring) management is more inclined to make large capital purchases than to increase hiring.

Figure 1: U.S. Industrial Capacity Utilization

Source: Murenbeeld and Associates

Another corporate tax change that may be impacting job creation is the dividend tax cut. By lowering the tax rate on dividends to the rate on capital gains, the tax policy has encouraged firms to transfer some of their working capital out of the firm in the form of rising dividends. The result? Less money is available to build new plants, undertake major capital projects and to increase hiring. Not only that, but the overall effect of increased dividend payouts on the overall economy is very modest. Studies have shown that over half of all dividend-paying stocks reside in tax-exempt accounts: pension plans and retirement trusts. The benefit of increasing dividends is that tax-exempt portfolios grow, but the money is not reinvested back into the economy in any meaningful way.

The unemployment rate may be signaling to economists that the economy is stronger than it really is. How could this be so? Because the employment rate is just the number of people working divided by the total work force. In previous economic recoveries, the unemployment rate has dropped as more and more people have gotten jobs. But in this recovery, the unemployment number is dropping (the appearance of more people getting jobs) because more and more people are dropping out of the labor force. In other words, it is not an increase in hiring that is causing the rate of unemployment to fall (the numerator) but fewer folks showing up in the government's statistics as available for work (labor force - the denominator).

While technically not considered in the official unemployment rate, there has been a large increase in number of people working part time. This group consists of people who are looking for full-time work yet they have to settle for a part-time schedule. While large numbers of part-time workers has no bearing on the unemployment rate that the government publishes, it is a huge benefit to employers and a drag on full-time hiring. By hiring two part-time employees rather than one full-time employee, firms benefit by reducing their overall labor costs, as well as health care and benefit costs.

Figure 2: Underemployment Trends

Source: Economic Policy Institute

A final reason for slower than anticipated job growth could be management's reluctance to resume hiring. After the stock market bubble popped in 2000, many executives have been adjusting to the new reality. Their stock options have been re-issued with lower strike prices and are finally above water, after a three-year dry spell. With corporate execs less willing to gamble on a recovering economy, that spells trouble for job seekers who are hoping to benefit from record profits that U.S. businesses have been racking up.

No matter what the cause, the pace of job creation is nowhere near were it should be at this point in an economic recovery. The weak level of job creation coupled with surging corporate profitability serves to highlight the fact that U.S. manufacturing is an increasingly less important source of job creation and that positions in the services industry, if they aren't overly unique, are increasingly vulnerable to outsourcing to low wage countries. Investors should steer clear of investments in traditional U.S. centric manufacturing companies (e.g. Ford and General Motors) and should consider highlighting energy and commodity producers in their portfolios.


StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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