A Very Different Way Strong Employment Gains Help Bolster Economic Growth

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Robust hiring and low headline unemployment means companies are finding it more difficult to hire talent – at least for the wages on offer.

GDP report showed underlying strength in consumer spending – but weakness in capital investment.

In order to compete on price and extract more output from existing staff, companies may make more investment in equipment and technologies.

A strong dollar makes imported capital goods cheaper and makes price competition by U.S. companies all the more important, arguing for boosting productivity gains.

Higher productivity can boost economic output, both in the short run with more capex investment, and in the long run with more income growth.

The GDP report, on the headline, appeared to be rather weak. Digging into the details of the report, however, painted a different picture, one of underlying strength, including robust consumer spending, as I recently wrote. One negative factor is the downturn in business investment in property, plant and equipment.

Difficulty finding qualified workers

The jobs data, however, was more robust for the past two months - and with rising wages as well. The linkage between consumer spending and more people employed (and more of them earning higher wages) is rather intuitive, and in fact, downright obvious. But what are the second-round effects of lower unemployment? The answer is that businesses will need to find a way to make their existing workforce more productive, as a dwindling pool of qualified workers make expansion more difficult.

Indeed, the National Federation of Independent Businesses reported recently in its Business Outlook Survey, "[Business] owners are still reporting that they cannot find qualified workers and cite it as their third "Single Most Important Business Problem." Indeed, the report noted, "Twenty-nine percent of all owners reported job openings they could not fill in the current period, up 2 points, the highest reading in this expansion."

Lower unemployment may boost capital spending

And that may mean more investment in equipment and technologies that boost output to make up for a dearth of qualified labor. After all, productivity - the output per hour of work - isn't due so much to a single worker producing ever more toasters on an assembly line. Rather, it's new machinery and processes that allow workers to produce more with the same inputs of labor. It is only natural, at some point, for businesses to substitute capital for labor when labor becomes more expensive or scarce.

For that reason, consider the inverse relationship between changes in business capex investment and changes in the unemployment rate, as seen in the nearby graph.

Part of this is, of course, due to the fact that, during a recession, at least, businesses are more likely to cut investment at the same time they lay off workers. But observe the relationship in the graph outside of recessions. The same inverse relationship holds true then, even though the economy arguably is faring relatively well. Simply examine the periods of economic expansion in recent decades in the nearby graph, which offers a good, observational view.

We've become accustomed to thinking of the unemployment rate as a lagging indicator, even though the unemployment rate spikes higher during recessions: neither very much before nor long after. The sustained fall in the unemployment rate to 4.9% according to the Bureau of Labor Statistics, a level arguably within the range of full employment (at least as stated within the ranges offered by the Federal Reserve and various Fed officials individually) argues for a bump in business capital investment. In other words, unemployment isn't just an effect of economic activity; it is also a causative factor as well.

Does a strong dollar hurt - or help?

Now, you might ask, what could be different this time around? Could the strong dollar be a reason why businesses might not invest, if a strong dollar may make competition from overseas producers more difficult? Consider the nearby graph, which illustrates an imperfect correlation between the relationship between the dollar and capex investment. Sometimes, there is a positive relationship, sometimes a negative one.

What then do businesses view of the level and direction of the dollar when choosing whether to invest more in capex? There are two considerations. One is the fact that many businesses import machinery and equipment, so a strong dollar makes those imports cheaper. Another is that businesses must compete with lower-priced imports and locally-made goods abroad in foreign markets, making productivity gains all the more essential to limit costs. So, to the extent that businesses compete against overseas companies, they may up their capex investment to compete on price. And a stronger dollar may make importing those equipment and technologies less expensive at the same time.

The longer term effects

These investments take time to plan, order, and finally implement new technologies. Recognizing the need to invest in new projects doesn't mean that factories don't sprout up overnight or that equipment is deployed immediately. Thus, we might not see an increase in investment right away.

But as long as companies have a need to improve efficiencies to compete on price with goods made abroad, and as long as companies face an increased difficulty in hiring, we may see an eventual increase in business investment. And that can be accretive to economic growth in months ahead. After all, the primary means of raising living standards is growing productivity, as that is the essential ingredient to allow companies to boost wages and maintain their profit margins at the same time.


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