Mindorenyo

Tuesday, March 10, 2015

Another Problem with the Conventional Wisdom

I've posted a couple of times already this year about problems with the conventional wisdom.  As I'm off work this week and have had Bloomberg on TV much of the time (in the background), I'm being bombarded with another item of conventional wisdom that seems way off.  Again, this is not one that is unique to Republicans or Democrats.  Both seem to be accepting this item of bogus conventional wisdom.

The item I am talking about is the effect of (un)employment on the economy as a whole.  The conventional wisdom is that the economy is poised for take off on the strength of recent gains in employment.  Story after story predicts that U.S. consumer spending will take off soon, continuing a self-sustaining spiral of growth.  In reality, spending has actually gone down in recent months, in tandem with decreasing prices.

Every economist should know that employment is a trailing indicator.  Companies hire more when spending is increasing, and vice versa.  With spending decreasing, falling employment is sure to follow.  Apparently this will come as a great surprise to the Democrats, Republicans, and the financial industry.

To some extent, this is a "chicken or egg story".  Which comes first -- higher employment leading to increased spending, or lower spending leading to decreased employment.  But a closer look at current situation reveals that employment is still weak and that recent gains are minor in terms of purchasing power.  For example, note that Average Hourly Earnings of Production and Nonsupervisory Employees are growing at the second lowest rate since 1964.  There is a much higher correlation between wages and spending than there is between employment and spending.  

The other argument supporting the conventional wisdom is that lower prices, especially for gasoline, will boost spending on other products and services.  This is no doubt true to some extent, but so far, after 6 months of plummeting prices, this effect has not been big enough to notice.  What has been noticeable is that the world economy is weak and that many U.S. businesses are experiencing lower exports and profits from abroad.

So imagine that you are a U.S. business.  You may have hired some additional employees over the past year, but revenue growth over the past year has been very low compared to most years, and negative in recent months.  Obviously you are going to reduce hiring.  This applies to even greater extent to large multinationals which are now seeing US wages increase sharply in relation to wages in other countries, due to the strength of the US dollar.

To reiterate the basic point-- With spending decreasing, falling employment is sure to follow.  Apparently this will come as a great surprise to the Democrats, Republicans, and the financial industry.