I keep reading personal finance bloggers saying there’s no recovery in sight because unemployment is rising.
This is backwards thinking. Unemployment is a lagging indicator.
In this post I’ll explain what that means, and why unemployment only turns down after the economy picks up.
I’ll also look at two contrary views, and say why I don’t think they’re true.
Leaders and laggers explained
Firstly, let’s quickly recap the three kinds of indicators used by economists when trying to understand the economy:
- A leading indicator is one that happens before an economic shift. For example, stock markets are often said to predict events months or even years ahead of economic events.
- A coincident indicator changes exactly in time with the economic trend. Demand for goods and services is a coincident indicator, directly related to a country’s current production.
- A lagging indicator trails behind economic events on the ground. Everyone can surely agree that unemployment fell after the economy hit trouble, not before?
Economists love to squabble – it’s all that coffee, I think – and they do debate whether some indicators are leaders or laggers.
But none seriously question that unemployment is a lagging indicator.
When would you hire?
So much for the theory – it’s actually easy to apply common sense.
Imagine you run a small local garage. You did well in the boom years but the recession hit you hard and you had to make cutbacks to survive.
One day you start to hear news reports claiming the economy is picking up. After months of false promises from politicians you doubt the reports, but then you start to get more queries on the forecourt and on the phone. What’s more, your local tire supplier needs you to confirm next month’s order now, because he’s running low on stock.
Pretty soon it feels like almost as many people want your services as before the recession…
…Problem! You had to fire three of your 10 staff a year ago to keep the business afloat. You held on as long as you could when demand fell (lagging alert!) because you didn’t want to lose good people. But now that demand seems to be picking up, you can’t expect to serve everyone with seven staff.
You’ve steered through a recession that almost killed your business.
Do you:
- A: Work your remaining staff harder, cutting down on coffee breaks and goofing around, and promising to make it up when you’re fully staffed again?
- B: Buy a new online booking system for the price of a month’s wages to squeeze in more customers at times when your seven staff can serve them?
- C: Hire one extra worker, and another part-time, to test the waters and see if the economy really is back to strength?
- D: Hire three new workers and explain to your bank manager that you’re sure this time the recovery is real, not another false dawn?
If you said D, you probably went bust in 2008 due to your optimism. Most companies start with their own version of A, move on to B, and then eventually, reluctantly, hire new labour with option C.
Returning to full strength, D, is a last resort – not because employers are evil, or because they don’t want to serve more customers and make more money, but because hiring and laying off staff is expensive and risky.
Unemployment lags productivity gains, as employers squeeze more from the same people. Eventually hours worked go up as they sanction overtime and hire part-time staff, and so productivity drops. Some time after that they start hiring as demand keeps growing.
This is exactly what is happening, with incredible US productivity gains [1] now tailing off, but output still rising:
4th Feb 2010: Productivity of the U.S. nonfarm business sector slowed a bit in the fourth quarter as hours worked increased for the first quarter since the second quarter of 2007, the Labor Department estimated Thursday
The productivity of the U.S. nonfarm business sector rose at an annual rate of 6.2% after a 7.2% gain in the third quarter. Output rose 7.2% in the final three months of the year and hours worked increased 1.0%. […]
For the year, productivity rose at a 2.9% rate, the fastest pace since 2003.
Yesterday’s expectation-busting results from Cisco [2] are another piece of the jigsaw. Companies have cut to the bone, and are now increasing spending on infrastructure as they see demand pick up.
I’m not that old, but every recession I’ve seen has ended with what some call a jobless recovery because they forget or distrust this hiring cycle. Don’t believe the guff.
Is it different this time?
Many bloggers write nonsense about unemployment because they don’t know any better, but there are two more thoughtful arguments being put forward, mainly in the US where unemployment has hit important psychological levels.
The first one says basically ‘the rise in US unemployment is so big, it’s self-fulfilling’. The argument goes that the 10% unemployment rate is enough to make companies downgrade their forecasts and to not risk hiring, because they can see the drag on the economy in those jobless queues.
I’m sure it happens a bit, but I don’t think it really changes anything. It just makes unemployment a bit more laggy, perhaps. If it turned into a vicious cycle we’d never escape recessions, and we do.
The second argument is ‘this is de-leveraging, it’s different’.
The argument here is that every chunk of excess debt in the system supported so many extra jobs. Take out the debt, and the jobs go with them.
This has some truth in it, I suspect, and there’s no doubt getting weaned off debt is going to take years.
However I don’t think it stops unemployment being a lagging indicator. It probably means employment will rise more slowly, and perhaps the final jobless total will be higher at the peak of the next cycle than the last.
Finally, beware of absolute numbers such as “10 million more US workers without a job compared to the last recession”. The US population is rising at 1% a year, so there’s millions more looking for jobs compared to last time, too.