Poor Employment Numbers Mean The Economy Will Be Bad

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by: Steven Hansen

It is easy to start blaming poor economic conditions for the poor jobs growth. But what if the poor economic conditions were caused by poor jobs growth?

Consider that the widely used tool of GDP as the economic metric is misleading pundits on economic dynamics. Bean counters always have problems with cause-and-effect as they cannot visualize dynamics and must calculate it based on what they understand - money flows.

Most employment models are based on monetary metrics (such as GDP based Okun's Law) to forecast jobs growth - employment is considered a lagging indicator of the economy.

If one stares at the relationship between GDP and employment, GDP leads employment - and this is "proof" that employment is a byproduct of GDP.

But GDP is not a measure of Main Street - and consumerism is over 2/3rds of the economy. Since GDP is essentially equal to GDI (gross domestic income), and 2/3 is related to consumption, how can it be that GDP can lead employment? That is a question I will leave on the table.

It is likely the relationship between retail sales and employment is the tattle-tail for the economy. When retail sales growth drops below employment growth, the economy is on an economic warning path. The red areas under the employment growth curve are economic contraction warnings, while the green areas above the employment growth curve are period of economic expansion.

One might notice that in June 2012, the growth rate of employment and retail sales came close to inverting.

It is not too far of a stretch once one realizes employment is part of the economic dynamic (and not a byproduct) - to state that employment growth is a (major) factor which causes economic growth - and it has been a very good determinate historically of an oncoming recession. The graph below shows when population adjusted employment growth falls below the zero year-over-year growth line, a recession is imminent.

If employment is a driver for GDP (and not a byproduct), what is causing the poor jobs growth? The primary reason is that new business starts are well below pre-Great Recession levels. Small business is the engine for employment growth.

The chart above is from the BLS's Business Employment Dynamics - Fourth Quarter 2011. It shows that new business is not being formed at past rates. I have continually stated that employment dynamics changed around 2000 - and likely is the reason for slow economic recovery for recent recessions.

If I were to guess at the cause of reduced business starts, it is the barriers to creation of a new business:

  • permits - what permits do you need to open a lemonade stand, or a gas station, or a restaurant.
  • regulation - what are the plant requirements for the lemonade stand, or gas station, or restaurant.
  • administrative - the paperwork required for compliance including payroll.

Another possibility is that potential business entrepreneurs simply do not see a demand for what product or service they would provide and that is the reason they take no action. I have not put that on the above list, but it is something that cannot be completely dismissed. Red tape would not stop most who felt confident they could launch a successful new venture. Fear of not having a market would.

Cause and effect is hard to determine when two elements seem to move in tandem - and one is blinded by believing the lead item (GDP) is determining employment. But more importantly, if employment is a significant driver of the economy - then concentrating on employment (and not elements of GDP) is what the monetary and fiscal controllers of the economy should be doing.

My normal weekly economic review was posted in my instablog. I have discussed the BLS Jobs report and ECRI's renewed recession call.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.