Following World War II, typical economic downturns and recoveries have been “V” shaped. That is, a sharp downturn in Gross Domestic Product and rising unemployment followed a quick turnaround in both economic activity and employment numbers. This time is different. We are witnessing zero or negative job growth and an anemic recovery.
Today’s situation is a different animal: a balance sheet recession. Both businesses and individuals took on too much debt. And that debt was unsupported by income. We are now saving to pay down that debt (the most recent savings rate increased to 6.4%), or defaulting on obligations (in May home foreclosures rose 44% to a new record).
Paradoxically, second quarter earnings demonstrate that corporations are beating earnings estimates and reporting healthy profits. Gluskin, Sheff reports that
…78% of the companies reporting have beaten estimates and earnings per share are up 42% year over year versus initial expectations of 27%.
Companies have focused on tight cost controls to achieve these results. The most recent durable goods report provides a clue to how costs are being controlled.
Orders for non-military capital equipment excluding aircraft climbed 0.6 percent last month after jumping 4.6 percent in May, more than previously reported, figures from the Commerce Department showed in Washington. See Second Quarter Earnings: Companies Beat But Investors Shrug
Looking further, we see we are in a jobs depression. Karl Denninger slices through the obfuscatory government data and finds that from July 2009 to July 2010 unemployment is 17% worse. See Watch the Birdie (Jobless Claims). After trillions of dollars of stimulus and guarantees and a zero interest rate policy, all we have to show for the effort is zero, or negative, job growth.
My strong suspicion is that management is substituting capital for labor.
A Brief Anecdote
One of my friends is the cost cutting guru for his company. Always on the lookout for new labor saving technology, he found a type of packaging machine that could replace five employees currently performing the function manually. His view is that labor saving technologies are the only thing preventing the economy from crashing. By laying off those five employees, the machine pays for itself in two years or less.
On the other hand, employees unionize, get sick, go on vacation, file worker’s compensation and discrimination claims, and go out on pregnancy and family medical leave. As an employer, machines suffer none of these disabilities. Substituting capital for labor is firmly rooted in all corporate cost cutting strategies.
Unintended Consequences
With Obama, Bernanke, Geithner and Summers setting economic policy, I always feel it is improvisation night. This team seems to bounce from one economic policy to the next with little thought given to unintended consequences.
- Zero Interest Rates – I have written about the pernicious effect of zero interest rates on savings, especially for senior citizens. See e.g. Is the Administration Determined to Make the Elderly Poor? Nothing from Nothing. However, the upside is that low interest rates encourage the creditworthy to borrow for capital investment. For example, IBM was able to borrow at 1% for 3 years. If you can purchase labor saving machines with low interest rate loans and tax depreciation savings, why not?
- Expensive Social Programs – Ignoring high levels of unemployment and economic stagnation the Obama Administration pushed ahead to pass health care reform. The law does not apply to businesses with less than 50 employees. The perverse effect is obvious:
…potential tax penalties for employers with more than 50 workers could cause many smaller businesses to rethink any hiring or expansion plans.
“It could have a negative effect on hiring as businesses figure out just how much the new law and offering health benefits will actually cost them,” many … small business clients have kept their staffs below 50 workers to avoid the complicated compliance requirements of laws such as the Family and Medical Leave Act.
“The new tax penalties for businesses with more than 50 employees will certainly make many business owners think twice about expanding and hiring more people….” See Small Businesses Ponder Impact of Health Care Reform
Add in the threatened expansion of unions through the Employee Free Choice Act and no wonder large and small businesses are reluctant to hire.
Machines Make Better Employees
At its core, the Democratic Administration has failed in its campaign promises to reduce unemployment and get the economy back on track. Through its zero interest rate policy the Federal Reserve and the Administration have “manufactured” our current high unemployment rate. Today’s jump in new unemployment claims, to a weekly rate of only emphasizes the point. See Weekly Initial Unemployment Claims Increase to 479,000
The net effect is that machines provide better value than employees. The labor market has structurally changed and not for the better. Zero interest rates coupled with zero forethought is harming the working population.
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