Chicken or Egg: Employment Is the Real Economic Driver

Written by Steven Hansen

It is easy to start blaming poor economic conditions for the poor jobs growth.  But what if the poor economic conditions were caused by poor jobs growth?

Consider that the widely used tool of GDP as the economic metric is misleading pundits on economic dynamics.  Bean counters always have problems with cause-and-effect as they cannot visualize dynamics and must calculate it based on what they understand – money flows.

Most employment models are based on monetary metrics (such as GDP based Okun’s Law) to forecast jobs growth – employment is considered a lagging indicator of the economy.

If one stares at the relationship between GDP and employment, GDP leads employment – and this is “proof” that employment is a byproduct of GDP.

But GDP is not a measure of Main Street – and consumerism is over 2/3rds of the economy.  Since GDP is essentially equal to GDI (gross domestic income), and 2/3 is related to consumption, how can it be that GDP can lead employment?  That is a question I will leave on the table.

It is likely the relationship between retail sales and employment is the tattle-tail for the economy.  When retail sales growth drops below employment growth, the economy is on an economic warning path.  The red areas under the employment growth curve are economic contraction warnings, while the green areas above the employment growth curve are period of economic expansion.

One might notice that in June 2012 – the growth rate of employment and retail sales came close to inverting.

It is not too far of a stretch, once one realizes employment is part of the economic dynamic (and not a byproduct) – to state that employment growth is a (major) factor which causes economic growth – and it has been a very good determinate historically of an oncoming recession.  The graph below shows when population adjusted employment growth falls below the zero year-over-year growth line, a recession is imminent.

If employment is a driver for GDP (and not a byproduct), what is causing the poor jobs growth is the question.  The reason is that new business starts are no where near pre-Great Recession levels.  Small business is the engine for employment growth.

The chart above is from the BLS’s BUSINESS EMPLOYMENT DYNAMICS – FOURTH QUARTER 2011.  It shows that new business is not being formed at past rates.   I have continually stated that employment dynamics changed around 2000 – and likely is the reason for slow economic recovery for recent recessions.

If I were to guess at the cause of reduce business starts, it is the barriers to creation of a new business:

  • permits – what permits do you need to open a lemonade stand, or a gas station, or a restaurant
  • regulation – what is the plant requirements for the lemonade stand, or gas station, or restaurant
  • administrative – the paperwork required for compliance including payroll.

Another possibility is that potential business entrepreneurs simply do not see a demand for what product or service they would provide and that is the reason they take no action.  I have not put that on the above list, but it is something that cannot be completely dismissed.  Red tape wouldn’t stop most who felt confident they could launch a successful new venture.  Fear of not having a market would.

Cause and effect is hard to determine when two elements seem to move in tandem – and one is blinded by believing the lead item (GDP) is determining employment.

Other Economic News this Week:

The Econintersect economic forecast for September 2012 shows moderate growth continuing. Overall, trend lines seem to be stable even with the fireworks in Europe, and poor data from China. An emotional component of my mind cannot help thinking this is the calm before the storm. But a logical component in the same cranium sees there are no recession flags showing in any of the indicators Econintersect follows which have been shown to be economically intuitive. There is no whiff of recession in the hard data – even though certain surveys are at recession levels.

ECRI stated in September 2011 a recession was coming . The size and depth is unknown. A positive result is this pronouncement has caused much debate in economic cyberspace. I will be glad when ECRI removes this warning (and hopefully not when the economy actually crosses into darkness).  Yet, ECRI is still insisting a recession is here (from a 07Sep2012 post on their website):

Recession Evidence Obscured in Real Time

In recent weeks, several key coincident indicators have surprised the consensus to the upside, bolstering the belief that the U.S. economy has dodged recession. Even though the latest releases may show increases, earlier data have almost uniformly been revised downward, a reality largely ignored by many. For example, after revisions, there is a net gain of only 55,000 jobs in today’s payroll jobs report, which is itself subject to further revisions.

Amid these cross currents, ECRI has completed an in-depth study of after-the-fact revisions to coincident indicators, revealing that they themselves display distinct patterns around business cycle turning points.

With preliminary data often obscuring real-time evidence of recession, our analysis underscores the importance of having an array of robust leading indexes for real-time monitoring of the economy.

The ECRI WLI growth index value improved this week enjoying its second week in positive territory. The index is indicating the economy six month from today will be slightly better than it is today.

Current ECRI WLI Growth Index

/images/z weekly_indexes.PNG

Initial unemployment claims declined from 374,000 (reported last week) to 365,000 this week. Historically, claims exceeding 400,000 per week usually occur when employment gains are less than the workforce growth, resulting in an increasing unemployment rate (background here and here). The real gauge – the 4 week moving average – rose slightly from 370.250 (reported last week) to 371,250. Because of the noise (week-to-week movements from abnormal events AND the backward revisions to previous weeks releases), the 4-week average remains the reliable gauge.

Weekly Initial Unemployment Claims – 4 Week Average – Seasonally Adjusted – 2010 (blue line), 2011 (red line), 2012 (green line)

/images/z unemployment.PNG

Data released this week which contained economically intuitive components (forward looking) were

  • Rail movements (where the economic intuitive components continue to be indicating a moderately expanding economy).
  • Jobs Reports – Although good jobs reports historically have little correlation to the economy, bad ones foretell bad times.  In this regard, this week’s reports are not foretelling bad times (or good times either).

All other data released this week does not have enough historical correlation to the economy to be considered intuitive, or is simply a coincident indicator to the economy.

Weekly Economic Release Scorecard:

ECRI’s Weekly Leading Indicator Growth Is More Positive for w/e 31 August2012
BLS Jobs Situation in August 2012 Disappoints
America: 10 Big Questions and 10 Honest Answers
Options for Newbies – Part 1
New Record for Global ETF, ETP Investing
Is there an Energy Transition? How to Invest
Inflation and Gold
NFIB Believes There Was Little Small Business Employment Growth in August 2012
Rail Week Ending 01September2012: Still Expanding Excluding Coal
ECB: Sovereign Bond Buying to Begin
August 2012 ISM Services Index Continues to Show Expanding Economy
Challenger August 2012 Job Cuts at 20 Month Low
01September2012 Unemployment Claims: Weekly Claims Down, 4 Week Average Up
August 2012 ADP Jobs Growth a Healthy 201,000
Dr. Draghi: Name Your Poison
The Fall of 2012
Artemus Ward Returns to France
U.S. Competitiveness Declines
Conference Board Reports Help Wanted OnLine Contracts In Again in August 2012
July 2012 CoreLogic Home Price Index Strong Improvement – Now Up 3.8% Over Last Year
Productivity 2Q2012 (Final): Improvement over Preliminary Release
Cassini Space Probe: Astounding Saturn Fly-By Photos
The Gold Standard
Internal Devaluation for the U.S.?
Average Gasoline Price Rises $0.066 Week Ending 03September2012
New King of Dividends: Tech Sector
Did Dodd-Frank Solve the Big Banks “Too Big to Fail”?
July 2012 Private Construction Spending Expanded At a Good Pace
August 2012 ISM Manufacturing Survey Again Declines
Stratfor: Character, Policy and the Selection of Leaders
War Against the Cities
Render Unto Caesar, Part II
AOL (and Others) Raise Dividend
Europe: Contraction Continues and Stress Rises
Forward Markets: Macro Strategy Review August 2012
Intro to Microfinance 101
EURUSD Analysis – Week of 3 September 2012
Great Debate©: Which Presidential Ticket Deserves to Lose?
China: Both PMI Readings Indicate Contraction, Asian Stocks Decline
50,000 Year Old Humanoid Genome Sequenced
David Schultz: The Corporate University Bubble Has Burst
The Week Ahead: All About Jobs on Labor Day
Canadians More Optimistic About Jobs
Insider Trading 31 August 2012: Carl Icahn Buying Forest Labs and Federal-Mogul
Reflecting on Plato, Aristotle, Midas and Wealth
Top 5 Mistakes Business Make When Considering Bankruptcy
This Week’s Data Dispells Recession Fears For Now
Fixing the Mortgage Mess: The Game-changing Implications of Bain v. MERS
Quanticipation in the Gold Price

Bankruptcies this Week: Journal Register

One reply on “Chicken or Egg: Employment Is the Real Economic Driver”

  1. Yes, if we can have capital requirements for banks based on perceived risks, which only guarantee us, sooner or later, obese bank exposures to what is erroneously perceived as absolutely safe, why can´t we have capital requirements for banks based on job creation potential ratings?

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