Economies go through cycles, with periods of expansion inevitably followed by periods of slowed growth and even contraction. Trying to determine when the next contraction will occur is among the chief tasks of economists, and also of vital importance for anyone who is investing. As such, this article is going to consider a chief factor that I believe could cause the next economic downturn, namely a stagnant labor market now plagued by frozen wages and chronic underemployment.
At first glance, this view would seem to stand in contrast to recent developments in the labor market. The United States has been adding jobs as of late, and while July's 209,000 jobs added fell short of the projected 230,000 jobs anticipated, it still marks the longest streak of 200,000+ jobs added since 1997.
Meanwhile, the employment rate is down to 6.2 percent from 7.3 percent only a year ago, a solid overall improvement, even if the rate did tick up .1 percent in July. (It should also be noted that this minor increase was likely due to a large number of formerly discouraged workers restarting their job hunt.)
In spite of the seemingly good news outlined above, the twin forces of automation and outsourcing are increasingly adding dark linings to otherwise strong economic indicators. Stock markets have performed well this year, even if they've stumbled the last few weeks, but trends in the labor market could come to threaten the stability of financial markets. Compared to twenty years ago the demand for labor, and especially unskilled labor, simply isn't as high as it used to be. So let's take a deeper look at the labor market.
Wages Have Stagnated
Economics 101 states that if demand is high and supply low, prices will rise. In a vibrant economy, demand for labor will be high, driving wages upwards. If demand for labor is low, however, wages will stagnate, if not decline. As of now, it appears that wage growth has indeed stalled.
Americans are among the most productive workers in the world, and yet over the last few decades growth in wages have declined, and as of late have nearly stopped all together. In July wages rose by a whopping penny, and since 2011 wages have been averaging growth of only 2 percent (YOY), well below the historical average of 3 percent.
Another way to consider wages is as a portion of the Gross Domestic Product. Until 1975 wages accounted for about 50 percent of the national GDP but have since gradually declined. Following 1975, wages gradually declined until the mid nineties, when they made up less than 45 percent of the GDP. In the late nineties the ratio of wages to GDP began to grow, reaching 47 percent in 2000 before once again shrinking.
Of course, these issues are not being ignored by policy makers or investors. Janet Yellen has been making wage growth an increasing focus for the Fed, though so far policy makers haven't unlocked the secret to raising wages while also not overburdening businesses.
Part-Time Work Is the New Norm
Then there's unemployment, one of the most widely cited economic indicators. The U3 unemployment rate ticked up .1 percent, but most economists aren't worried about this, citing the number of people rejoining the job hunt as the reason for the increase.
The U6 unemployment rate, however, remains high by historical standards, at 12.6 percent. The U6 is arguably a more accurate measure of the economy as it includes all the groups of the U3 and also people working part-time while desiring full-time employment, plus marginally attached workers, which includes people who want to be employed but have given up on the job hunt.
The problem with the widely cited U3 unemployment rate is that it makes almost no qualitative considerations for who is actually employed. If you drop out of the job hunt, you're suddenly no longer unemployed. And if you're working 10 hours a week even though you really want and need a full time job to pay your bills, you're still employed.
It's also worth noting that even the U6 doesn't consider situations where people are taking jobs they are vastly overqualified for. So that former middle manager at Acme Shipping who lost his career job, but found himself too old with outdated skills and thus settled for a job flipping burgers at a fast food restaurant is technically employed. Same with the recent college graduate who finds herself waiting tables while looking to start a career in her field.
Consider, for example, that the United States added 288,000 jobs in June, one of the strongest months for hiring on record. Economists should have been rejoicing, right? During that same time frame, however, the number of people working part-time increased by 1 million, rising to 27 million. While these numbers might have been impacted by recent college grads accepting part-time work while looking for a full-time career job, or other similar circumstances, the fact remains that more and more people are now working part-time.
In fact, as of June 7.5 million people were involuntarily working in a part-time job. Perhaps this number doesn't sound too alarming, but it's a huge increase from the 4.4 million people who were in the same situation in 2007 before the financial crisis hit. Thankfully, this is down from the peak of some 9 million people in 2009, but is still exceptionally high given that the United States is supposed to be in the midst of a "strong" recovery.
People Giving Up On The Job Hunt
Meanwhile, more and more people simply aren't looking for a job. Many workers who have spent months looking for employment and sent out who knows how many resumes -only to get the cold shoulder of silence- are simply giving up on the job hunt. As we already mentioned, the government does not count these people as unemployed in its official U3 rate, because somehow that makes sense.
Of course, from the point of view of the economy, this person is still unemployed. Their labor and productivity is going unused, and they are not generating an income. This second point is vital as developed economies depend on consumer consumption. If people are not working, they will not be generating an income, and this in turn means they won't have as much money to spend.
The U-4 unemployment rate, which includes "discouraged workers," rose to 6.6 percent in July, up from 6.5 percent in June and considerably higher than the official 6.2% U3 unemployment rate. Thankfully however, the recent spurt of optimism does appear to be encouraging more people to look for work, which helps explain why the U3 unemployment rate rose. Still, the number of people too discouraged to look for work is exceptionally high.
Labor Force Participation Rate Continues Downward Slump
Another way to look at the above issue is participation in the labor force. Before the Great Recession, about 66 percent of working age people participated in the labor force. The rest stayed home, often by choice.
Since the Great Recession participation in the labor force has steadily declined and even in spite of the recent spurt of economic growth, has actually reached new lows. In May, the labor force participation rate bottomed out at 62.8 percent. July saw a slight uptick to 62.9 percent but participation is still far below historical norms.
What does this mean? Quite simply, many working age people are not participating in the labor force, and it's unlikely that it's because more parents are choosing to stay home to take care of their children, or pursuing other personal interests.
Total Amount Of Money For Consumption Remains Stagnant
Wages are essential for generating discretionary income, which can then be used for personal consumption. Total wages and salaries paid out weighed in at 6.86 trillion in the first quarter of 2012, rising to only $7.46 trillion in the first quarter of 2014. While this rise may seem substantial at first glance, it's important to remember that inflation has slowly been eroding the value of the dollar and that the population itself is growing, meaning that more people should be employed.
Further, with the unemployment rate also shrinking, in theory the total amount of money paid out in wages should grow as companies hire more employees. And yet even in spite of the dramatic decline in unemployment over the last few years, the total amount of money paid in wages has barely increased.
Meanwhile, the average savings rate of Americans has been declining. At the end of 2012, personal savings accounted for about $1.1 trillion but have since declined to $682.9 billion. One possible explanation for this decline is that people are simply spending more of their savings to buy goods, even if their income is not growing.
Indeed, personal consumption numbers are far larger than the total amount of wages and salaries paid per year. In the first quarter of 2012 Americans spent $10.95 trillion through consumption, rising to 11.86 trillion in the first quarter of 2014. This means that Americans are spending far more than they are earning, at least in terms of wages. Of course, many Americans have other forms of income, such as social security and investments. Still, rising consumption, in combination with stagnant wages, could be a potential red flag for unsustainable activity.
End Conclusion: Economy Setting Itself Up For A Crash
So what's the point of all of this? Right now, many indicators are pointing to solid economic growth, which at least for the near term should keep markets buoyant. And yet, underlying problems -massive cracks even- are beginning to show. The so-called recovery might prove to be nothing but a false mirage unless the labor market starts to post genuine growth. This means rising wages, increased labor force participation rates, increased full-time employment, and a corresponding drop in the U6 unemployment rate.
Yet with companies looking to cut costs through automation and outsourcing as much work as possible to lower wage economies, it's difficult to see what industries and employers will drive strong economic growth. According to Keynesian theory (among others), increased consumer consumption, something that is occurring at the moment, should lead to increased economic activity and job growth.
Problem is, in the new economy, most of the jobs created in the United States will be low wage service jobs. Yes, John might land a high paying job (perhaps as part of a government stimulus package) and rush out to buy a new TV, computer, and other goods. A large portion of his income, however, will flow overseas. Many of the jobs in the USA created by John's consumption will be low wage service jobs. Sure, someone has to sell John that TV, but he or she is probably working at Wal-Mart (NYSE:WMT) and making close to minimum wage.
In a real sense, consumption may be slowly decoupling itself as an engine of economic growth, with increased consumption resulting in little more than the creation of more low wage jobs, and perhaps increased short-term profits for some companies.
This isn't to say that outsourcing or automation are bad, when handled right. Other countries, such as Germany and Singapore, have enjoyed success in the continually globalizing world economy. Many people in the United States, on the other hand, are struggling.
On the whole income levels remain stagnant. Numerous pundits have argued that these numbers are skewed, pointing out such remarkable things as how much cheaper it is to buy a washing machine today than it was 40 years ago. According to them, sure, wages may be stagnant but people are actually able to buy more. Of course, such a perspective ignores the skyrocketing costs of college and health care, among other things.
Speaking of health care, another argument is that while wages may have stagnated, that's simply because employers are offering other benefits. Among other things, employers are shelling out more for health care, but this isn't because they are providing better health care plans, but instead because health care is simply becoming more expensive.
Of course, if wages do start to improve, then the economy may be able to avoid a pronounced downfall. Even if wages do start to improve in the short term, however, it'll be important to examine the situation to see if it's just a temporary occurrence, or part of a larger trend. Certain things could send wages upwards and increase demand for labor in general. Obviously, increasing the minimum wage would be one method of raising wages, though doing so could have detrimental effects on inflation and the costs of doing business. Another technology boom, or a similar event, could also raise employment.
Either way, neither of those conditions or any other similar events appear to be on the horizon. At least for now, stagnant wages and an economy that generates an increasing number of low-pay, part-time jobs seems likely to be the norm. If so, it's only a matter of time before the impacts of such an economy will be felt on the market. Does that mean this year, next year, or the year after that? Specifics are always difficult to predict but economists, investors, and everyone else would be wise to pay close attention to the indicators outlined in this article, and other related pieces of data.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.