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Jobs aren't enough

21 August 2019

US unemployment has fallen to historic lows and job creation remains robust. GAM Investments’ Larry Hatheway considers what is behind this jobs phenomenon and its longer-term economic implications.

This article was originally published by Project Syndicate

The current US economic expansion is extraordinary. It rivals the longest on post-war record. Unlike its predecessors, it has not unleashed much inflation. Corporate profits have soared to unprecedented levels. Economic inequality is at its most extreme in a century.

Each of these unique features is paradoxically linked to a final oddity. Despite a mostly lacklustre expansion since 2009, the unemployment rate has declined significantly more than would have been predicted by GDP growth alone.

Using a simple model relating unemployment to GDP growth—akin to ‘Okun’s Law'—the rate of joblessness has fallen a half a percentage point more per year during this expansion relative to what history would have suggested. Since 2014, the rate of employment growth exceeded what GDP growth would have predicted by nearly 1 million jobs per year.

Even as unemployment has fallen to historic lows, job creation remains more than double the rate of growth of the labour force. Firms are hiring strongly despite tepid growth, a dwindling pool of productive workers and in the face of troubling political and policy uncertainty.

What explains the jobs phenomenon?

Perhaps firms are substituting cheap labour for expensive capital. On the surface that looks plausible—labour is relatively cheap. The share of total worker compensation in national income has fallen steadily this century, reaching a low of 60% in late 2014, before edging back to its present level of 62%. Yet that is still three full percentage points below its average level from 1965 to 2000.

On the other hand, returns on capital are exceptionally high. Since 2010 the share of corporate profits in GDP has attained average levels unrivalled in the post-war era. One might think that firms would prefer to invest in high returning capital, not labour. But that’s not the case. The average annual rate of non-residential gross fixed capital formation since 2009 has been 5.3%, essentially the same as it was in the expansions of the early 2000’s or the 1980s, and well below the investment-led boom of the late 1990s.

Why is cheap labour so abundant? Perhaps workers are willing to sacrifice higher wages in return for job security. That’s understandable, given the painful memories of many workers from the great recession. Wage demands may be restrained by angst about losing jobs to China, Mexico or to machines. Yet a rising ‘quits rate’, now back to levels seen prior to the financial crisis, suggests excessive worker caution may be lessening.

Another factor is declining union membership. In the early 1980s nearly a quarter of the US labour force was unionised. Today that figure has fallen to almost a tenth. Non-union workers make, on average, about 20% less than their unionised counterparts.  A less unionised labour force offers work more cheaply and, perhaps, more flexibly, increasing the appeal of hiring.

Still, the most important factor behind sluggish wage growth is probably weak productivity growth. Average labour productivity in the US (and in most other advanced economies) has slumped in the past decade. Despite the explosive growth in information technology, the average worker is not becoming more productive.

Soggy productivity helps explain the anomalies of this expansion. If output per hour worked isn’t rising much, then the number of hours worked must rise to ensure adequate provision of goods and services. Hence, despite pedestrian GDP growth, job creation remains robust.

Furthermore, firms cannot lift pay faster than the increase in the marginal product of labour. Low productivity growth therefore explains sluggish wage gains. In the absence of stronger productivity growth, firms also are less willing to invest. Capital discipline contributes therefore to high returns on capital, which underpins soaring profits and yawning income inequality.

How can policy respond to ensure that the benefits of growth are more equally distributed? It is unlikely that the populist responses from both ends of the political spectrum, such as calls for protectionism or universal basic income, will do the trick. They will simply ensure that Americans fight over shares of a shrinking pie.

Rather, the key is to raise average levels of productivity. For a variety of reasons, including the political and social backlash against capitalism, today’s productivity challenge cannot be addressed solely by 1980s-like appeals for deregulation, lower taxes and less government. Economic efficiency will have to be augmented by improvements to energy and transportation infrastructure, better access to quality education, worker training and healthcare.

Solving the productivity puzzle cannot be left to markets alone. Left unresolved, the productivity malaise will ensure that this expansion will remain uniquely imbalanced and unhealthy.

(Copyright: Project Syndicate, 2019)

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