Facing a weakening labor market, it's time to focus on the 'real economy'

We've begun to feel the pain of a recession in the real economy and that pain will get worse before it gets better. So far in 2008, job losses have averaged about 85,000 per month, but in September the number was 159,000. W. P. Carey economics Professor Lee McPheters says that we could be in for at least 6-9 more months of job losses. Says McPheters: "My expectation is that there will be some months in the early part of 2009 with job losses much greater than the 159,000 jobs lost in September, possibly double that amount."

On October 3, between news about Wells Fargo's interest in ailing Wachovia and the House vote on the $700 billion rescue plan, news media took a break from the financial crisis to report that the U.S. economy had lost 159,000 jobs in September. But it wasn't too long until the focus was back on the global financial crisis.

Newspaper headlines over the last month have been dominated largely by the global financial crisis. Less attention has been paid to topics like job growth and unemployment rates — though they affect average Americans much more directly than tumult on Wall Street.

That tide may be changing, though, said economics Professor Lee McPheters, who is director of the JPMorgan Chase Economic Outlook Center and editor of Economy@W. P. Carey.

"Over the past weeks, the focus in the media and in Washington and New York has been on the financial side," McPheters said. "The $700 billion financial rescue plan will benefit the economy, but it doesn't much affect unemployment and job growth — which are much more germane to the average worker."

Now, McPheters said, policymakers will have to turn to the "real economy" — which refers to such indicators as output (GDP) and employment growth. In spite of the government's help for the financial markets — what McPheters calls massive and innovative injections of liquidity into the economy — "the consensus among economists is that the real economy is in or on the brink of recession right now," he said.

Understanding this recession

Perhaps that shouldn't be surprising, if history is any guide. "It seems that periods of excess are followed by a contraction and we are in another one at this time," McPheters said. The recession of 2001, for example, was a reaction to the tech bubble bust (as well as September 11th). The recession of 1991 was precipitated by a real estate bubble and the savings and loan crisis.

The economy's current downturn, McPheters said, "can be traced primarily to the downturn in residential building," which is now the weakest component of GDP. "While homes are being built, the level of activity is shrinking, not growing." Through the first half of 2008, though, other positive factors boosted the economy — including export sales, strong because of the weak value of the dollar, non-residential (commercial, retail, and office) construction, and consumer spending.

Of those, perhaps the most important is consumer spending, which now accounts for 70 percent of GDP. "Consumer spending had been growing by 1-2 percent," McPheters said. "It wasn't the 3-4 percent we had seen in the past few years, but it was still growing." Now, though, "it is believed that the consumer has stopped spending, both due to weak consumer confidence and tighter credit conditions."

Other factors that have influenced the halt in consumer spending include job losses (which are increasing), high gas prices (which have fallen only recently), stagnant consumer incomes and high levels of consumer debt. "Consumer spending cannot drive the economy forward in that environment," said McPheters.

Labor market outlook

And consumer spending will likely decrease further if confidence — which drives spending — continues to be depressed by bad news from the job market. "The health of the labor market is particularly important as a factor influencing consumer confidence," McPheters explained.

"Monthly job losses and rising unemployment signal weakness in the real economy and also cause consumers to become more cautious, reducing outlays on big ticket items as well as smaller discretionary spending categories such as restaurants and entertainment." When that kind of spending accounts for 70 percent of the economy, further declines in confidence and spending certainly don't bode well.

Already, McPheters said, labor market figures have undermined consumer confidence and have contributed to weakness in the stock market. "So far this year, nonfarm (establishment) payrolls as reported by the Bureau of Labor Statistics (BLS) are down 760,000 jobs overall. Unemployment now stands at 6.1 percent — compared to 4.9 percent in January and 5.5 percent in May. According to the BLS, there are now 9.5 million workers unemployed, the highest number since December of 1992."

And McPheters believes the worst is yet to come. "It is my projection that if the current downturn is similar to past contractions, the headlines for job losses and unemployment will become much grimmer in months to come," he said. So far in 2008, job losses have averaged about 85,000 per month. In the 1991 recession, monthly job losses averaged 147,000. In the 2001 recession, losses averaged more than 180,000 jobs a month — more than double what we've seen so far this year.

"If this current downturn is as severe as most analysts seem to believe, we are in for at least 6-9 more months of job losses, which will be much larger than we have seen to date." And while average month job losses fell under 200,000 in the two most recent recessions, both had months during which losses exceeded 300,000. "There is nothing about the current recession that suggests it is going to be milder than previous recessions," McPheters said.

"My expectation is that there will be some months in the early part of 2009 with job losses much greater than the 159,000 jobs lost in September, possibly double that amount." In terms of unemployment rates, McPheters sees 7 percent unemployment at the national level as very likely in the next six months. "Unemployment rates in the recession of 1991 were above 7 percent for 18 consecutive months," he said.

He projects that unemployment — standing at 6.1 percent nationally now — will rise to 1991-like heights. The outlook, though, isn't uniform across states. Those states that are still adding jobs may slow down somewhat, McPheters said, but are expected to outperform most other states and the nation as a whole in 2009. The top states whose labor markets are still strong (still adding new jobs) include Texas, Wyoming, North Dakota, South Dakota and Washington.

In contrast, 22 states lost jobs according to the September report. "At the bottom are Georgia, Florida, Michigan, Arizona and Rhode Island, having the weakest job markets in the nation, losing jobs at the fastest pace of decline," said McPheters. Because, as McPheters explained, the current downturn was precipitated by the real estate bust, it's not surprising that the five states with the strongest job markets didn't have the same kind of overheated housing market as the five states with the worst job markets.

"The top five states did not experience the housing bubble, prices did not rise as fast and homes were not overbuilt, so there's not an excess of inventory," McPheters said. As a result, "construction jobs are still increasing in the top five states and both residential and commercial construction projects are underway."

Among the five states with the worst job markets, "all suffer from high levels of foreclosures and Florida and Arizona, at least, have real estate markets with huge inventories of unsold homes," McPheters explained. How bad might it get for the states? "The worst period for unemployment in the post-war period was the recession of 1982, during which 30 states recorded double-digit unemployment rates," McPheters said.

"As the economy continues to weaken, it is likely that the California unemployment rate will exceed 8 percent and Michigan will move into the double-digit level." But while the labor market outlook is pretty dour for many individual states (as well as on the national level), some sectors of the economy will fare better.

"The sectors of the economy hit hardest by job losses include construction, finance, real estate, as well as those industries affected by high oil prices, including motor vehicle sales and trucking," McPheters said. "Health care and hospitals, in contrast, continue to add jobs and appear to be recession-proof, as of now."

Overall, McPheters explained, health care is one element of consumer spending that tends to hold up during recessions. Several factors are in play now, he said, to bolster the relative strength of the health care industry. Those factors include aging baby boomers, who are and will continue to consume more health care services; the fact that the government funds a portion of health care spending; and a general rising demand for more medical services, regardless of the state of the economy.

Switching the policy focus

State-by-state and sector-by-sector differences aside, the bottom line, McPheters said, is that "although there has been concern about the health of the economy since the housing sector began to decline, job losses and unemployment rates so far have been rather mild compared to past downturns. If we are on the brink of recession as most analysts believe, we can expect much larger monthly job losses going in to 2009 and higher unemployment rates, which will further depress consumer confidence and consumer spending."

But just as the government has been able to help redirect the financial markets away from the precipice, so can it help alleviate the pain of the coming recession. In general, McPheters said, "the policy focus will have to switch to such initiatives as extending unemployment benefits, a possible stimulus package of some kind, and continued efforts to stimulate lending and credit expansion through monetary policy."

Extending unemployment benefits would help people who have been most directly affected by weakening job markets — those who have lost jobs and find it increasingly difficult to find new ones. A stimulus package, which Fed chairman Ben Bernanke suggested to Congress this week, would aim to encourage consumer spending, which in turn would (ideally) strengthen companies, which would (hopefully) lead to higher employment.

Stimulated lending and credit expansion to get loans to consumers and businesses would ideally stimulate both consumer and business spending. Nevertheless, McPheters' outlook is clear: We've begun to feel the pain of a recession in the real economy and that pain will get worse before it gets better.

Bottom Line:

• Policymakers will have to turn from the financial markets to the "real economy," which, according to most economists, is in or on the brink of recession right now.
• If this current downturn is as severe as most analysts seem to believe, we are in for at least 6-9 more months of job losses, which will be much larger than we have seen to date.
• Unemployment — standing at 6.1 percent nationally now — will very likely rise to 7 percent in the next six months.
• The top states whose labor markets are still strong (still adding new jobs) include Texas, Wyoming, North Dakota, South Dakota and Washington.
• Georgia, Florida, Michigan, Arizona and Rhode Island have the weakest job markets in the nation and are losing jobs at the fastest pace of decline.
• The sectors of the economy hit hardest by job losses include construction, finance, real estate, as well as those industries affected by high oil prices, including motor vehicle sales and trucking. Health care and hospitals, in contrast, continue to add jobs and appear to be recession-proof, as of now.
• Policymakers' focus will have to switch to such initiatives as extending unemployment benefits, a possible stimulus package of some kind, and continued efforts to stimulate lending and credit expansion through monetary policy.