Daily Archives: March 9, 2012

The US employment report for February contains further evidence that, on the surface at least, the American labour market is returning to normal. The unemployment rate of 8.3 per cent is 1.7 percentage points below its peak in October 2009 and private sector employment has risen by a healthy 2.1 per cent in the past 12 months.

Yet consumer pessimism about job prospects remains almost as bleak as it was in the darkest hour of the recession. If the labour market is really improving as much as the official data imply, no one seems to have told middle America.

Ben Bernanke, chairman of the Federal Reserve, is also puzzled. Last week, he pointed to the fact that the jobs data have improved much more than they should have done, given the relatively weak growth rate of real gross domestic product in recent quarters. The link between changes in the unemployment rate and real GDP growth is captured by “Okun’s Law”, named after John F. Kennedy’s economic adviser, Arthur Okun.

This law, which celebrates its 50th birthday this year, has held up rather better than most economic relationships. However, it does not explain the recent decline in the unemployment rate.

Real GDP has grown by only 2.5 per cent per annum since unemployment peaked. This is close to the trend growth in productivity. Using Okun’s Law, this implies that there should have been no decline at all in unemployment during the economic “recovery”. In the past 12 months alone, the unemployment rate has fallen about 1.3 percentage points more than implied by Okun. So what is going on?

Employment gains have certainly been strong in recent months. But over a longer period, the most credible explanation for these puzzles is that the labour force has been growing much less strongly than normal. The participation rate, defined as the sum total of employed plus unemployed as a percentage of the relevant population, has actually fallen from 65 per cent at the height of the recession to 63.9 per cent now.

Normally, it would be expected to rise during a recovery, as previously disaffected workers are drawn back into the jobs market. This time, potential workers seem to have drifted away from the labour market, and not come back.

The labour force has therefore “downsized” itself in line with the economy. Part of this is due to demography and particularly to the rise in the proportion of workers who are near retirement age. They often choose to retire early. But it also seems to be due to the exceptional depth of the recession, which has persuaded many workers that there is no point in actively seeking work.

The shrinkage of the labour force, part voluntary and part involuntary, leaves the potential output of the economy lower than it was before and may explain why Americans do not perceive this recovery in the labour market as a genuine one.

It is a major relief that the labour market is now clearly improving. But the financial crash of 2008 continues to cast a very long shadow on America’s economic potential.

The writer is chairman of Fulcrum Asset Management and a founder of Prisma Capital Partners

The release of February’s economic data confirmed that Chinese growth is slowing down. Consumer inflation fell to 3.2 per cent last month, the lowest since June 2010. Weaker industrial production, retail sales and export data all support the same pattern. China’s days of double digit growth are, at least for this century, probably over. The data releases following a “forecast” from outgoing premier Wen Jiabao that gross domestic production growth would be “only” 7.5 per cent this year, an estimate that seemed to surprise many observers. Does this mean China’s glory days are numbered and reforms including currency reform are over? Not at all.

Much of China’s slowing is neither unexpected nor undesired. Premier Wen’s forecast was not news to those who follow developments in the country closely. In the 12th five-year plan released about a year ago, the leadership had already said that it expected real GDP growth of 7.5 per cent. It was seen at the time as confirmation that Beijing was no longer pursuing as fast a rate of GDP growth as possible. While such assumptions are only a vague gauge of policy intentions, they are nevertheless a broad signal of what the leadership desires to achieve. While actual GDP growth has consistently exceeded expected growth for many years, this didn’t stop Beijing from lowering their stated and assumed target.

A number of factors explain this plan. First, it has been clear since 2008 that the days of massive Chinese export growth to the west were over. Second, this can’t be replaced by generous government investment spending. Third, rapid GDP growth has become self-defeating, placing considerable strains on China’s resources and environment, forcing up commodity prices, bringing inflationary pressures and rising wealth inequality. Too fast GDP growth had outlived its purpose. Fourth, inflation is threatening social stability as low income urban citizens see their real wealth eroded. All of this meant lower economic growth has become not only necessary but desirable.

But let’s get things in perspective. A real growth rate of 7.5 per cent, if it occurs, along with four per cent inflation will still see China’s GDP, in US dollar terms, close to doubling in five years so long as the currency doesn’t nosedive. By early next decade China’s economy would near $15tn and be on track to surpass the US. For the rest of the world, 7.5 per cent growth in China is effectively the same as US growth of around four per cent. As I have become fond of saying, China today creates the equivalent of another Greek economy every eleven and a half weeks, and one-tenth of another eurozone economy every year.

Seen in these terms, lower GDP growth is not a hindrance to reforms, it is an essential ingredient. Softer but more balanced, sustainable and higher quality growth requires reforms, including of the renminbi. To complicate matters, currency reform does not equal currency appreciation. The renminbi is going to become more volatile like other currencies. It will go up as well as down against the dollar, partly because China’s current account surpluses are coming to an end, but also because it is opening up its capital account. In recent weeks, policymakers have published detailed guidelines and in some ways, a timetable for all sorts of reforms. Many of them can’t be achieved without currency reform. This includes better-quality GDP albeit at a slower rate.

By 2015 there is a good chance that the renminbi will be part of the ‘special drawing rights’ basket, the International Monetary Fund’s key accounting tool that lies at the heart of the world’s monetary system. The value of the renminbi will go up before then, and it will also go down. Just as with teenagers, it’s all part of growing up.

The writer is chairman of the asset management division of Goldman Sachs and former chief economist at the investment bank

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