Friday, December 16, 2011

The Disconnect Between Stocks and Employment

Unemployment remains stubbornly high, and the eurozone crisis lurches from one bailout package to the next.

Quoted in this morning's Financial Times, IMF Managing Director Christine Lagarde gave a speech in Washington yesterday warning that the world faces the risk of "economic retraction, rising protectionism, isolation and...what happened in the 30s {Depression}".

With this miserable background, why does the US stock market remain reasonably buoyant?

There are many reasons, of course, but one might be the simple fact that profitability is at all-time highs, largely based on the incredible efficiency gains that technology has brought to Corporate America.

On the other hand, looking at data going back to the end of World War II, labor compensation as a percentage of total nonfarm business output has never been lower.

Put another way: corporate profits have fully recovered to 2007, but labor's share of those profits continues to decline.

Even with stagnant wage growth, companies simply don't need to hire as many people as they had in previous recoveries to achieve the same levels of output. Moreover, some of the fastest growing businesses (i.e. technology) simply don't need that many people.

For example, Google employees around 27,000 people, and continues to hire at a fairly rapid clip. However, by comparison, General Motors in the 1970's employed well over 100,000 people through its operations.

I don't think this is just a political question. You can argue about worker retraining, or the need to improve our education systems to compete in the 21st century, but the huge amount of workers who cannot find work is a tremendous economic burden as well.

Here's how the FT put it yesterday:

{The share of income that has fallen to workers}has fallen to its lowest level after records began after the second world war and is part of the reason why incomes at the top - which tend to be earned from capital - have risen so much. If wages were at their postwar average share of 63 per cent, workers would earn an extra $740bn this year, according to FT calculations.

And since the marginal propensity to spend is higher for lower wage workers, imagine how much stronger economic growth would (not to mention tax revenues!) if we can get the employment picture to brighten.

In the meantime, though, we will probably continue to have this disconnect between capital market performance and economic reality.