Stephen King: US recovery is creating jobs, just not in the US

The markets hoped they'd get an elephant but, in fact, they got a mouse that sent the dollar lower

Talk about wishful thinking. Throughout last week, the markets got more and more agitated about what might be termed "The Big One", the statistical release that everyone, everywhere, gets excited about. Yes, I'm referring to last Friday's US employment report. Before its release, the markets were increasingly thinking that, at last, they'd get a strong payrolls number. But "The Big One" decided to stay at home.

The markets hoped they'd get an elephant but, in fact, they got a mouse. A mouse that sent the dollar lower against sterling and the euro. A mouse that led to a rally in US bonds. And a mouse that stood up to the world and roared out its message loud and clear: "The US is still facing a jobless recovery."

For the record, non-farm payrolls rose just 21,000 in February, all of which were the result of government rather than private sector gains. When the total number of people employed is more than 130 million, this is no more than a tiny drop in a very big ocean. For months now, the markets have been hoping for "The Big One" - an increase in payrolls of 300,000-400,000, or perhaps even more, signalling the beginning of a true recovery - but, as each month goes by, disappointment has become almost habitual. Although other US economic indicators have performed very well - the business surveys have been strong and GDP growth in the second half of last year was buoyant - the jobs market remains a major obstacle to lasting economic health.

So why are jobs not being created? One reason might be that the Bureau of Labor Statistics is simply not measuring the jobs market accurately. There are plenty of optimists around who are very happy to claim that jobs growth is everywhere other than in the numbers themselves.

One argument in favour of this claim is based on the idea of outsourcing. Take, for example, a long-standing manufacturing company that decides to outsource its catering facilities. The manufacturing company tells the labour market statisticians about its job losses because it is no longer employing the caterers. The catering company that now employs these caterers, though, might not be big enough to fall under the beady eyes of the labour statisticians. As a result, the job losses are recorded, whereas the job gains are not.

I have no problem with this argument. It sounds entirely plausible, apart from the obvious point that any "assumed" job gains must, at this stage, be no more than hearsay. But to focus on this argument alone, and ignore other arguments that work in exactly the opposite direction seems, to me, like a case of "selective hearing", rather than an objective statement of the risks involved in interpreting employment data.

The optimists will argue that this is not just selective hearing. They will point out, quite reasonably, that limited progress on jobs growth sits uneasily with the recent steady decline in the unemployment rate (although this is an argument that doesn't work as far as the February data are concerned, where the unemployment rate failed to budge below the level seen in January.) If the unemployment rate has been falling, can it really be possible that jobs growth is really so weak?

The answer, unfortunately, is "yes". The so-called participation rate - a measure of those people of working age who make themselves available for work - has fallen rapidly over the last couple of years, after rising rapidly in the late-1990s. During the late-1990s boom, people were sucked into the workforce who, in normal circumstances, would not have bothered: they decided to work because the demand for labour was so incredibly buoyant.

As the labour market has weakened, and as wage growth has slowed, these people have become increasingly disillusioned. In effect, they have exited the labour force altogether, and count as neither employed nor as unemployed. Under these circumstances, it is entirely possible to have job losses without a rise in unemployment. If this is the case, the labour market is a lot weaker than the unemployment numbers suggest.

To be honest with you, I cannot tell which of the above explanations is the more accurate. So, at this stage, it's worth keeping an open mind. Nevertheless, there are good economic reasons for thinking that the US labour market could remain weak for quite some time. I've argued before that one of the reasons behind the ongoing sluggishness of the US labour market is the impact of global outsourcing and offshoring. Companies may be hiring more workers but there is no reason why companies should specifically be hiring US workers.

Ultimately, companies have to please their shareholders. Faced with a lack of pricing power and, in some cases, sluggish sales growth, they have no choice but to cut costs. New technologies, forcing the pace of globalisation, have made it that much easier for companies to lower costs by shifting capital around the world to areas where labour is relatively cheap.

Economics textbooks have, in the past, ignored this phenomenon, assuming for the most part that labour is mobile but capital is not. But with the collapse in communication charges around the world associated with the introduction of new communications technologies, this assumption is no longer safe. If capital is now a lot more mobile, economic expansion is likely to look very different from the past.

My hunch is that the payrolls figures will remain soft throughout 2004. Yes, the markets will continue to look for "The Big One". Some people will continue to argue that inflation is just around the corner. And speculation over when the Federal Reserve will raise interest rates will not die away.

These hopes and fears may, however, prove to be nothing more than that: just hopes and fears. If companies are doing well precisely because of their ability to outsource and offshore, it makes no sense whatsoever to expect a recovery in corporate profits to feed through to a recovery in workers' incomes. In this Brave New World, profit strength - and labour market strength in China and India - may be driven by exactly the same processes that are giving rise to labour market weakness in the US.

So, no "Big One". As a result, the Federal Reserve will shy away from raising interest rates. The cyclical upswing in profits and the bounce in economic activity will not lead to higher inflation. Bond markets will remain well behaved, as they begin to come to terms with an economic expansion associated with little in the way of labour market pressure and, hence, little in the way of pressure on prices. The dollar will continue to decline, as the US Administration tries anything to create some jobs ahead of November's Presidential election. And the election itself will take on an increasingly protectionist hue, as Messrs Bush and Kerry increasingly attempt to win the hearts and minds of the American people by finding other countries and regions to blame for the lack of US jobs growth.

Stephen King is managing director of economics at HSBC

stephen.king@hsbcib.com