Another Spring Passes
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For the past three years, the economy and the stock market began the New Year on a strong note only to falter as the year progressed. So far this year, both the economy and the stock market appear to be holding up quite well—the Dow momentarily rose above 15,000 for the first time, and the economy grew 2.5% in the first quarter. But what does the remainder of the year have in store? Is the economy likely to extend the gains from the first quarter, or are we doomed to repeat a familiar pattern of strong growth giving way to weakness?
This month we are revisiting the outlook for the economy with a special emphasis on the labor market.
Since the end of the recession, the economy has been able to achieve a real growth rate of only 2.1% at an annualized rate. This pace is slightly below what economists estimate to be our long-run potential rate of growth. Such a slow pace of growth has severe implications for the labor market. According to recent reestimates of Okun’s law (a relationship between GDP growth and unemployment), we still need to get real growth up to about 4.5% for nearly three years to drive the unemployment rate down to about 5.0%.
The Economic Outlook
The largest single component of GDP, personal consumption, was relatively strong in the first quarter, at least compared to what we have come to expect. Real personal consumption expenditures grew at a 3.2% annual rate, following an increase of 1.8% in the fourth quarter. We expect consumption to slow in the second quarter before gradually increasing in the second half of the year.
This outlook is predicated on modest improvement in personal income growth and continued improvement in household wealth as both the stock market and housing continue to improve. The stock market, as mentioned, recently hit a new high, and the improvement through the first quarter should be sufficient to allow wealth to surpass its prerecession level.
The other primary component of household wealth is the value of owner-occupied housing. The housing market remains a bright spot in the economy. While this growth has shown some monthly variation, overall it is trending up. In March, new housing starts jumped 7.0% after rising 7.3% in February. New home sales rose 1.5% in March after falling 7.6% in the prior month. On the downside, sales of existing homes fell 0.6% in March following a 0.2% increase in February, but much of the weakness here is thought to be inventory related.
Existing home prices rose 6.4% in March, following a 1.5% increase the month before. Over the last year, existing home prices were up 11.8%; new home prices, 3.0%. Despite these increases, home affordability remains near record highs, and mortgages rates remain near record lows. While housing remains affordable, impaired access to capital continues to hamper demand.
The pace of business investment slowed in the first quarter. Equipment and software investment rose 3.0% at an annual rate in the first quarter after growing 11.8% in the fourth quarter. Investment in structures fell 0.3% after surging 16.7% in the prior quarter, stronger imports led to an increase in the trade deficit, and government consumption and investment fell 4.1%. On net, we expect the pace of growth to slow in the second quarter before gradually approaching 3.0% by the end of the year.
The Labor Market
Stronger growth in the first quarter was partly reflected in the latest jobs report. While April’s gain of 165,000 net new jobs was about the consensus expectation, data for the last two months were revised upward by a combined 114,000 jobs. The average growth over the past three months was 212,000. Private jobs grew by 176,000 in April, and revisions pushed the prior two months up by 124,000. The private sector increased by an average of 216,000 net new jobs per month over the past three months.
These gains were concentrated in the private services sector and in professional and business services categories. Although recent gains have mostly been concentrated in the services sector, one story that’s recently gained traction in the media is the resurgence of American manufacturing.
Manufacturing employment was unchanged in April at 11.99 million, but it is up from its trough of 11.46 million in February 2010. At the start of the latest recession, manufacturing employment was just over 13 million. While we are optimistic about some recent trends toward insourcing and new innovations in 3D printing, the manufacturing sector is unlikely to improve without increased consumer demand.
The Unemployment Rate
The most recent data from the household survey, which is used to calculate the unemployment rate, showed that the economy added 293,000 net new jobs in April, after falling by 206,000 in March. This pace was sufficient to lower the unemployment rate by one-tenth of a percentage point to 7.5% in April. Over the past three months, the survey has only averaged 86,000 net new jobs per month, but the unemployment rate dropped from 7.9% to 7.5%.
With such a poor performance in creating jobs, how is it that the unemployment rate has dropped from a peak of 10% to its current level of 7.5%? One reason is because of the so-called participation rate—the number of people in the labor force (those with jobs or actively looking for work) divided by the total working age (aged 16 and over) population. It is a measure of the percentage of the working age population who are contributing, or trying to contribute, to the productive capacity of the economy. Higher participation rates are generally seen as a positive for the economy. The current participation rate is 63.3%, down from 65.7% at the end of the recession, and it is at its lowest level since 1979.
In addition to the unemployed, about 2.3 million people are marginally attached to the workforce. These people are not actively looking for work and are thus not counted in the unemployment rate. An additional 7.9 million are working part time but would prefer a full-time job. These people are counted among the employed, but they are not bringing home a full-time paycheck. This number is over 3.5 million higher than its prerecession level. Such high levels of underemployment are indicative of a weak economy.
The government provides an alternative to the unemployment rate called the U-6, which attempts to measure unemployment and underemployment. This measure currently stands at 13.9%, up 0.1 percentage points from March, very high by historical standards.
Another indicator of the health of the labor market measures how long people who lose their jobs remain unemployed. Currently, the median duration of unemployment is about 18 weeks. However, median duration measures can hide extremes in the data. The average duration of unemployment is now over 36 weeks. Nearly half of the unemployed, or 5 million of the total of 11.7 million, have not worked for more than 27 weeks.
So while spring traditionally marks the end of the winter doldrums, past experience suggests that things may get worse before they improve. We know that in order to finally secure improvements in the labor market, we need sustained economic growth. However, we appear to be in for a bumpy ride with a modest slowdown in the second quarter before seeing some gradual improvement toward year-end. In the meantime, we need to reorient our economy with pro-growth tax reform, additional infrastructure investment, wiser use of our known energy reserves, and a less onerous regulatory structure.
U.S. Chamber Economist Brian Higginbotham is the primary author of this article.