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– October 25, 2013

While the Fed says it is waiting for more evidence that the recovery will be sustained, AIER’s business-cycle indicators continue to show a U.S. economy on an expansionary course, as they have for 33 consecutive months. 

Overall, the percentage of AIER’s primary leading indicators appraised as expanding reached 92 in August (11 out of 12 indicators for which a trend is apparent), up from 91 in July.  The cyclical score of leaders, which is based on a separate mathematical analysis, held steady at 90. 

With both measures comfortably above 50, AIER’s leading indicators suggest that the recovery is likely to continue.  AIER’s coincident and lagging indicators, all of which are appraised as expanding, confirm an economy in a growth pattern.

The Fed’s main concern is the sluggish job market.  Unemployment dropped only 0.1 percent in August, and another 0.1 percent in September. It now stands at 7.2 percent. This is far above the target of 6.5 percent that the Fed established as a benchmark before it would slow down pumping money into the economy. 

AIER’s indicators support the Fed’s concern that the labor market remains worrisome.

The average duration of unemployment, a primary lagging indicator, increased for the second month in a row in the most recent month. It went up to 37 weeks from 36.6 weeks the month before.  This is much higher than the pre-recession level, which was around 16 weeks in 2007. (See Chart 1 on page 3.)

Unemployment is considered long-term when it hits 27 weeks or more. The number of individuals in this category jumped to record levels in the Great Recession, as Chart 2 on page 3 shows. It still remains unusually high despite falling by 733,000 over the last 12 months. The number of long-term unemployed now stands at 4,290,000, accounting for 38 percent of the total  unemployed. 

The duration and level of unemployment is linked in part to the level and duration of unemployment benefits. The extended availability of unemployment insurance tends to reduce the search effort of a job seeker. During the Great Recession and the early months of the recovery, unemployment insurance was extended several times, allowing jobless individuals to collect up to 99 weeks of benefits in some states. 

According to theory, once extended benefits expire, the unemployment rate should decrease rapidly as available vacancies are being filled up.  In reality, even though extended benefits have expired and are no longer available, the rate and duration of unemployment are not responding as might be expected.

A study published this year by the Federal Reserve Bank of Boston offers an explanation of this puzzle.  It found that the disincentives of unemployment benefits only partially account for the increase in unemployment during 2000-2013.

Another reason for the current persistence of high unemployment and long duration is a mismatch between the skills of the unemployed and the skills desired by employers. Industries that were hardest hit during the downturn such as construction and manufacturing are still struggling to regain pre-recession levels of employment.  Employment in construction, for example, declined in the most recent month and now stands at 80 percent of its pre-recession high. The job openings rate in those industries is hovering around 1.7 percent per month on average.

Different jobs are opening. These jobs combine vocational training with the traits computers cannot simulate, such as creativity and people skills.  One such area of expansion is work in the technology-driven information sector. As Chart 3 above shows, the job opening rate in the construction and manufacturing industries is half that in the information industries.  Medical technicians, licensed practical nurses, and workers in education are also in demand.

But the transition from a construction site or an assembly line to a computer terminal or a hospital is not instantaneous.  It takes time to retrain and obtain new expertise. So the unemployment rate stagnates as the economy works through the skills mismatch. 

Simple population growth is complicating the problem for the jobs market. According to civilian employment to population ratio, an AIER coincident indicator, job growth is too slow to absorb increases in the number of people entering the workforce.  This ratio peaked in April 2000 at 64.7 percent. The civilian employment to population ratio now stands at 58.6 percent. This level has not been seen since October 1983, when the labor market was recovering from the massive job losses of the recession of 1981-82. 

The civilian labor force fell by 312,000 in August, the second consecutive month of decline.  This brought the civilian labor force participation rate down to 63.2 percent, a striking 5 percent drop from its peaks during the boom years of the late 1990s. The ratio has also dropped 3 percent from its pre-recession levels of 2007-08.

The decline in the labor force participation rate since the downturn has led to considerable research into its causes. Two factors are in play: cyclical changes brought on by the recession and long-term demographic and behavioral changes.

Intuitively, the aging baby boom generation should be retiring and contributing to the decline in the labor force. But the boomers’ share in the labor force has increased from 11.9 percent in 1990 to 19.5 percent in 2010 and is projected to reach 25.2 percent in 2020.

The high cost of health insurance and the decline in employer retiree health benefits are among the main reasons people are working beyond retirement age. In addition, the decline of traditional defined-benefits pensions have prompted older workers to continue their employment, as have individual desires to accumulate more Social Security or other retirement savings.

There are noneconomic benefits that also contribute to the decision to work longer. Emotional well-being and physical health improves when people remain active. Employment also promotes social interaction and social support. 

The trend towards longer employment is not just an outcome of the recession. Researches at Georgetown University’s Public Policy Institute found that since 1980 older adults are working longer. This is good news. When older adults delay retirement, this means that they are healthier. They consume fewer public benefits, pay more taxes, and contribute to higher levels of economic growth.

In contrast, the labor force participation rate for young adults aged 20-24 has declined since the 1990s. It is now at its lowest point since 1972. (See Chart 4 at right.) The problem of youth unemployment has been getting worse for several years. 

As blue-collar jobs such as those in construction have disappeared, young men entering the labor market without advanced education have had an especially difficult time in the labor market.  According to the Bureau of Labor Statistics, the share in blue-collar occupations held by men aged 20 to 24 declined from 54 percent in 1980 to 35 percent in 2010. 

Some of these young adults may find their way into jobs that are currently in demand through online and other training that may help them acquire new skills.

Changes in labor supply are not the only drivers of the current persistence of high unemployment.  Softness in labor demand is another driver. 

Commercial and industrial loans, one of AIER’s lagging indicators, have been on a strong upward trend that began in October 2010.  With interest rates near or at zero, businesses have invested in plant, machinery and commercial equipment. (See September’s Business-Cycle Conditions report).  They are now positioned to analyze their capacity utilization and to assess their hiring needs. 

Interest rates are expected to rise when the Federal Reserve starts unwinding its massive infusion of money into the economy. Businesses understand that. The expectations of higher interest rates are enticing businesses to continue borrowing to invest in technology and other labor-cutting processes. This is causing employers to postpone the decision to hire more workers.

Fewer job openings, in turn, affect the composition of people who are out of work.  The sluggish recovery has been characterized by a large number of people who are employed part-time, but would prefer to work full-time.

There is also a large number of people who are neither currently working nor looking for work, but indicate that they are available for a job and have looked for work sometime in the past 12 months. The combination of these workers, who are marginally attached to the labor force, with the actual unemployed and involuntary part-timers constitute 13.7 percent of the labor force or about 20 million people. 

This is high compared to recoveries in the past 20 years, when data began to be collected.  The average level for this group was around 9 percent during the previous recovery.  (see Chart 5 on page 5). 

The weaknesses in the labor market are clearly not enough to counter the overall positive outlook portrayed by AIER’s statistical indicators.  However, the 16-day government shutdown and the battle over the debt ceiling have been disruptive to the economy. These added to the uncertainty in the marketplace, affected consumer and business expectations, and reduced the government sector’s expenditures. Demand, which is already weak due to the softness in the labor market, was further diminished. 

Despite the conflict in Washington, the recovery is likely to continue, as our indicators show.

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Natalia Smirnova, PhD

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