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Investors Versus Workers: No Contest

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By TParadiso
October 16, 2003

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Investors Versus Workers: No Contest

Given the importance the economy and specifically job growth plays in almost everyone's lives, a follow up to last week's column is in order. Previously, we approached the subject as it relates to next year's presidential election. This week we'll look at it from the perspective of the inherent conflict that exists between worker and investor.

Almost every week, new data is released that provides clues to our future economic condition. Last week, the books closed on the federal 2003 fiscal year and the administration received some good news. The actual deficit came in at $374 billion, well below the most recent White House prediction of $455 billion. Hooray. Sounds like progress.

It is also a signal the administration has wised up. Previously, they had made every effort to portray the brightest economic picture possible. The problem with such an optimistic approach is it is prone to causing disappointment. So rather than risk having to continue to explain why the deficit was greater than expected, the administration picked a number they knew they could beat. If you doubt that's what the White House had in mind, consider the fact that its projection was over 10% higher than the Congressional Budget Office projection of $401 billion.

My only question is what took so long? This administration perfected the art of creating low expectations but they were reticent to apply the strategy to economic policy. Floating a high number was the right thing to do and should have been done long ago.

It's not a matter of trying to be deceptive as much as it is an attempt to create a positive mindset. Although it is difficult to quantify, consumer confidence plays a role in economic conditions because it can influence spending habits. Being pleasantly surprised goes a lot further than being continually disappointed when it comes to maintaining a confident consumer.

The lower than expected deficit was the result of a combination of things. Spending was lower on defense, Medicaid, unemployment, and for welfare programs. Tax receipts were also more robust, mostly from higher corporate profits.

Despite the improvement in tax revenue, as a percentage of the total economy, taxes are at their lowest level since Eisenhower was in office. In addition, tax revenues have fallen for three consecutive years. That's something that hasn't happened since the Great Depression. This would all be goodness if spending was held in check, but it wasn't.

The significance of the deficit is twofold. One is the obvious long-term problem of the increased interest cost on the debt and the inevitable need to someday pay it down. The more critical issue is short-term. A rising deficit could cause interest rates to increase. If that happens it could stymie the recovery. The risk of rising interest rates is impossible to estimate. At this point it has to be considered low but it's a concern nonetheless.
Higher interest rates pose a danger in both the consumer and business sectors. On the consumer side there is a risk higher rates could choke off the housing market. Home refinancing has already slowed. Fortunately home sales have remained strong.

On the business side higher interest rates mean a higher cost of capital. That translates into higher investment costs. One of the drags on the economy has been business capital investment. Increasing rates could cause business to continue to prolong its investment plans.

Now, the key issue: jobs. Here again the latest news was good. September marked the first time in eight months that the economy created new jobs. And last week, initial jobless claims declined. Treasury Secretary John Snow wasted no time jumping on the news. He declared that the evidence is "irrefutable and unmistakable" that the economy is rebounding. As premature and misguided as this position is, ya gotta love the enthusiasm.

It's analogous to believing the Red Sox game-one win against the Yankees was irrefutable proof the team was World Series bound. That's a good one. I get to slam both the Red Sox and White House simultaneously. But I digress.

It is true jobless claims fell to their lowest level since February. That's certainly positive. Unfortunately the dramatic drop in weekly claims was an anomaly. Two weeks ago Hurricane Isabel prevented many from filing. This caused an artificially high number of claims the week before last. The fact that last week's claims dropped was largely due to it being compared to what in effect was the combined total of two weeks of claims.

Snow went on to express "confidence we're going to see a pretty good job pickup in the months ahead." Perhaps Mr. Snow should have discussed the issue with some business leaders first. It wouldn't have been difficult. Eighty CEOs from Fortune 500 companies were assembled at the Business Council meeting in White Sulfur Springs, West Virginia.

During the CEO powwow, the chief executives discussed what course of action they planned for their companies. Apparently someone forgot to tell them an economic rebound was a sure thing.

Most of the business leaders do believe the economy will continue to grow next year. About 55% expect growth of 3%. The consensus among economists is for a 3.8% growth rate. It's not unusual for the business community to be more conservative than the economic community. What's encouraging is most people agree the economy will grow at between 3 and 4%.

Economic growth notwithstanding, there was a red flag raised regarding hiring. Only 14% said the pace of hiring would increase while 63% planned to maintain the status quo.

The news on the capital spending front wasn't encouraging either. About half expect spending to remain stable. Stable isn't going to cut it. Business investment has been depressed for quite a while and needs to pick up. A third did say they expected a small increase in spending. A small increase beats a poke in the eye with a sharp stick but it doesn't exactly signal a robust rebound.

Here's the problem. For many businesses top line revenue growth has been anemic. To maintain earnings growth and maximize stock prices, companies have relied on expense reductions and productivity improvements. From an investor's perspective that's the appropriate strategy.

Increased productivity is a good thing. It keeps companies competitive. It provides the same benefit to our economy on a macro level. But as discussed last week, in the short-term, high rates of productivity negatively impacts job growth. The result: the welfare of the worker and the welfare of the investor diverge. And who do you think is going to win that battle?

Compounding the problem is the rising cost of carrying employees. The economic downturn and tight job market has allowed businesses to keep salaries stable. However, they have not been able to control the cost of benefits, particularly health costs, which continue to rise at an alarming rate. As a consequence, companies hire more part-time and temporary employees and continue to put off full time hires. It appear they will continue to do so until they are assured the recovery is in full swing.

A couple of other factors exasperate the problem. Today, global competition is far more fierce and will continue to intensify. This has caused thousands of jobs to permanently move abroad. For years this phenomenon was isolated to the manufacturing sector. Not any longer. Now, it's happening with white-collar jobs as well.

Lastly, for many large companies, the downturn in the stock market has caused steep losses in pension funds. Federal Reserve Governor Susan Schmidt Bies indicated that at the end of 2002, 90% of the defined-benefits plans of Standard & Poors 500 companies were under-funded to the tune of $200 billion. The need to properly fund these pension plans will create further earnings pressures. To compensate, companies will look to cut expenses in other areas. Take a wild guess what will be high on the list.

This combination of factors makes this economic downturn different from previous ones. For example, by the third year of the 1990-91 recession the economy was adding 286,000 jobs per month. Next month marks the start of the third year of this recovery. I don't want to be a party pooper but something tells me we won't be adding a quarter of a million jobs a month any time soon.

A primary culprit: productivity. From 1980 to 1995 productivity increases averaged 1.4%. From 1996-2002 productivity has increased by 2.6%. Again, good for investors and overall competitiveness, but not for workers.

Despite the rhetoric coming from the Democratic candidates for president, by almost any measure of employment this recession has been mild compared to previous ones. The overall unemployment number of 6.1% is much lower than the majority of past recessions. The increase in unemployment has also been lower and the percentage of decline in employment from the peak has been smaller.

All of which illustrates that sometimes history doesn't repeat itself. That's true in spades when it comes to the economy. It may well be we are seeing a major economic transition not unlike the migration from an agricultural to a manufacturing-based economy. At these major inflection points, history can only tell you so much.

In fact, we are in the process of again transitioning, this time from a manufacturing-based economy to a service-oriented one. Adding a level of complexity is globalization and the rising influence of the capital markets. Combined, these factors may be creating an unprecedented set of dynamics that may magnify the different agendas of the investing and working worlds.

None of this is innately bad. As odd as it sounds, change is the only constant in an economy. As a country we have repeatedly demonstrated an ability to navigate through these periods and there is every reason to believe we will be successful again. However, it is unclear how long it will take.

With a presidential election looming, that becomes of paramount political importance. So far, the president has opted to placate the investment community while portraying his efforts as focused on job creation. The softness of this recession aside, that spin only flies if the job market turns before November 2004. If it does, workers and investors alike will be very happy. As will President Bush as he enjoys serving out his second term.


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