Churchill's Lament: The July Jobs Report

by: Douglas Adams

Summary

While July's headline job creation hit 255,000, well above consensus estimates, labor productivity continues to erode while unit labor costs continue to rise.

Wage growth through the end of the 2nd quarter hit 2.5%, according to the Employee Cost Index, while July's jobs report logged a 2.64% rise in wage growth year over year.

Wage growth without productivity gains will likely flat-line US GDP growth without further corporate investment in workplace efficiency and economies of scale.

The biggest news of the quarter in regard to wage growth came from The Employee Cost Index (ECI). Wages and salaries increased 2.5% year over year through the end of the 2nd quarter for all civilian workers. This was the strongest post for wage growth since the 1st quarter of 2015, when the Index surprised observers with a 2.6% surge in overall compensation for the quarter. Private sector wage & salary compensation jumped even higher with a 2.6% post over the same period. Public sector wage & salary compensation rose 1.7% through the end of the 2nd quarter, down from a 1.8% rise through the end of the 1st quarter and down from a 1.9% gain in June 2015. What is interesting is the report's emphasis on wages and salary, rather than total compensation, which also includes the ever-rising costs associated with pension and health benefits as well as supplemental payments such as bonuses. Personal income has indeed increased by $29.3 billion (0.2%) during the month, which is on top of a $27.0 billion (0.2%) increase in May and a $61.6 billion (0.4%) increase in April.

So just how is this recent wage growth impacting worker productivity? Labor productivity measures the amount of time needed to produce one unit of output and the change of that equation from one period to the next. That measure of change is influenced by a variety of variables: changes in technology, labor mix, labor skill set, capacity utilization, energy and raw material inputs, economies of scale in the production process, managerial skills and oversight, to name a few. Unit labor costs measure the relationship between output and worker compensation. An increase in labor productivity offsets compensation increases and, in turn, lowers unit labor costs. The reverse is also the case - decreasing labor productivity would be expected to increase unit labor costs, as it takes more labor to produce that unit of output given falling levels of productivity per hour worked. Compensation costs would likely increase as more labor units would be needed to maintain past levels of output.

Overall nonfarm unit labor costs increased 4.5% through the end of the 1st quarter from the 4th quarter as labor productivity declined 0.6%, while compensation increased by 3.9% for the same period. For the last four quarters, nonfarm unit labor costs have increased 3%, while compensation increased 3.7%. Meanwhile, labor productivity year over year increased at a more modest pace of 0.7%. In the 4th quarter, nonfarm unit labor costs were even larger at 5.4%, reflective of a 1.7% decline in productivity for the quarter and an increase in compensation of 3.6%. Fourth quarter year-over-year, unit labor costs rose 2.7%, while labor productivity fell 1.7%, and total compensation rose more modestly at 0.9% as output rose 1.5% for the period. For the past two consecutive quarters, the pattern has been remarkably similar: increasing unit labor costs, falling labor productivity and rising compensation. The pattern signals a combination of factors that point in the direction of either more workers with fewer skills being hired or less progress in achieving economies of scale in the production process due to falling levels of investment in labor-saving efficiencies in the workplace, requiring more labor inputs.

This better frames our discussion of the July jobs report. The headline number for the month came to 255,000 new positions: 217,000 new private and 38,000 public sector jobs for the month. The output was well above consensus estimates. While the national unemployment rate remained unchanged at 4.9%, both the labor participation rate and the employment-to-population ratio inched up slightly to 62.8% and 59.7%, respectively. The labor force increased by 407,000, while those falling out of the labor force dropped by 184,000 as more workers re-engaged with the labor force during the month. Workers accepting part-time work involuntarily largely remained unchanged during the month at 5.94 million, while the overall part-time workforce changed little over the course of the year at 21.3% of job holders.

Total private sector wage growth corroborated ECI estimates through the end of the 2nd quarter. July's year-over-year wage growth came in at 2.64% across 122.272 million private sector workers, compiling an average wage of $25.69 (see Figure 1 below). The percent increase in wage growth was unsurprisingly skewed across the listed industrial sectors. Information/technology workers secured the biggest year-over-year increase at 4.85%, while education/healthcare workers received the lowest percentage increase at 1.62%. Interestingly, information/technology sector experienced the second lowest positive increase of employees over the year at 0.58%, while constituting just 0.027% of the total private sector workforce. Meanwhile, the education/healthcare sector experienced the strongest increase in employees of all the sectors listed at 4.43% for the year, with wage growth that mirrored the PCE deflator for prices in the greater economy at 1.60% through the end of the 2nd quarter. This means purchasing power remains unchanged for the sector for the period, offset almost entirely by the prevailing rate of inflation. Education/healthcare employs the largest percentage of the private sector workforce at 18.58% through the month of July. At the lowest end of the wage scale, leisure/hospitality workers enjoyed a 4.04% increase in wages over the period and experienced a 1.88% increase in their numbers for a total of 15.546 million workers. Retail workers, which numbered 15.960 million, pocketed an above-trend 3.31% gain in wages, while expanding their numbers by 1.79% over the period. Together, the two sectors employ 31.506 million workers, or 25.77% of the private sector workforce through the end of July.

Figure 1: Wage Growth July 2015-July 2016 in Hourly Private Nonfarm Payrolls

Industrial Sector

Number of Employees (thousands)

Percent Change of Employees YOY

YOY Percent Growth

April Hourly Wage

Mining/Logging

682

-17.33%

2.27%

$31.94

Construction

6,652

-0.76%

2.96%

$28.20

Manufacturing

12,305

-0.82%

3.01%

$26.00

Wholesale Trade

5,922

0.14%

3.31%

$29.65

Retail Trade

15,960

1.79%

2.11%

$17.87

Transport/Warehouse

4,883

1.77%

1.92%

$23.33

Utilities

564

0.18%

3.52%

$38.50

Information

2,783

0.58%

4.58%

$36.54

Financial Services

8,281

1.08%

3.05%

$32.47

Professional/Business

20,257

2.12%

2.56%

$30.88

Education/Health

22,714

4.43%

1.62%

$25.70

Leisure/Hospitality

15,546

1.88%

4.04%

$14.92

Other Services

729

-0.19%

1.92%

$22.88

Total Private

122,272

1.04%

2.64%

$25.69

The contraction in the mining/logging sector was on vivid display during the month as the fallout from declining energy prices and forward capital investment continues to pound the ranks of the US oil patch, which logged the largest decline at 17.33% year over year. The renewed downward pressure on oil prices that are now in bear territory from their June market peak continues the bloodletting. The energy sector's pullback in investment remains an unprecedented drag on US economic growth, with no end readily in sight. Construction, manufacturing and other service providers, such as repair and maintenance, personal and laundry services, as well as membership associations and like organizations all shed workers over the course of the past year as wage growth narrowed across about 17% of the total private sector workforce.

The steady decline in US productivity from an average of 2.25% through the 1992-2000 period to 2.657% for the 2001-2007 period falls by more than half to 1.137% in the 2008-2015 period. Since 2014, nonfarm productivity has dropped below 1%. Meanwhile, the unit labor costs have increased to 2.925% in 2014 and 2.6% in 2015. The root cause of falling US productivity and rising unit labor costs remain true to Churchill's lament of Stalin's Russia: a riddle, wrapped in a mystery inside an enigma.

A final word on inflation: Higher wages often translates into price inflation in the greater economy. If such inflation trends pan out, this puts added pressure on the Federal Reserve to get out in front of such a rise, rather than to wait until for inflation to entrench before pulling the trigger on a Federal Funds rate hike. Through Friday's market close, the Federal Funds futures showed a 4% probability of just such a move coming out of the September FOMC meeting. That probability increases to 32% by the end of the year. With pent-up labor demand from May likely flowing into June's revised and July's headline job creation, numbers are impressive by recent historic measures, underlying productivity continues its downward march, giving the appearance that more workers are being added to payrolls just to maintain past output levels. Economic growth in the greater economy is likely to flat-line as a result - perhaps the high range of which has already been on display in the GDP numbers of the past three quarters. Meanwhile, corporate investment in labor-saving efficiencies in the workplace and economies of scale in the production process remain conspicuously on hold. Rising unit labor costs and falling corporate investment merely underscore the observation. Corporate earnings now face a fifth consecutive quarter of year-over-year decline, while ultra-low borrowing costs courtesy of central bank monetary policy continue to fuel corporate share buyback and enhanced dividend payout programs. The verdict on an interest rate hike this year? The jury continues to deliberate.

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