Understanding the Paradox of the Full-Employment Recession
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Chapter 1: The Current Economic Landscape
The economy presents an intriguing paradox: GDP is declining, prices are on the rise, yet unemployment remains notably low. Welcome to the concept of a "full-employment recession."
Recently, the Bureau of Labor Statistics released its preliminary estimate for GDP growth in the second quarter, revealing a contraction of -0.9%. This marks the second consecutive quarter of negative GDP growth, indicating a recession. However, with robust job creation and significant luxury consumer spending, is the U.S. truly in a recession?
In typical recessionary periods, economic output decreases, prompting businesses to reduce their workforce. This leads to a rise in unemployment rates, which generally climbs by 2 to 3 percentage points from pre-recession figures. This year, overall output has seen a decline at an approximate rate of 2.5% since January. Under these circumstances, one would expect unemployment to exceed 4%, a level often considered full employment.
Contrary to expectations, the unemployment rate has held steady at 3.6%. Recently, economists were astonished by the addition of 528,000 jobs, pushing the unemployment rate down to 3.5%. Equally perplexing is the fact that nearly 3 million jobs have been created since January. How can output be decreasing while the economy continues to gain new workers, particularly in sectors like luxury goods, travel, and leisure?
Exploring the 'Full-Employment Recession'
This apparent contradiction can be understood through the concept of a "full-employment recession." In this situation, economic output is declining—indicative of a recession—while simultaneously functioning at full employment levels.
The key to this phenomenon lies in examining worker productivity, which typically rises by about 2% annually. However, recent data reveals a significant decline in productivity: a 7.4% drop in the first quarter and a 4.6% decrease in the second quarter, marking an unprecedented decline.
To illustrate, consider a scenario where 100 workers produce 100 units daily. After a year, if their productivity increases to 102 units, that reflects a 2% growth. In contrast, this year, with 101 workers, total output fell to 98 units, reflecting a productivity decrease equivalent to an annualized rate of 7.4%.
The Challenge of Less Productive Workers
The conclusion is clear: businesses are hiring more employees, yet overall productivity is declining. The reasons behind this drop can be complex. It might stem from reduced productivity due to remote work arrangements or because newly hired workers—potentially unemployed for extended periods—may lack the necessary skills. It could take time for these individuals to become effective in their roles.
Positive job growth is likely to persist throughout the current recession, as the nation grapples with a significant labor shortage, particularly in service and blue-collar sectors. Despite the downturn in output observed in the first half of the year, the economy is currently operating at a higher output rate than before the pandemic. The number of employed individuals now closely mirrors pre-pandemic levels.
Currently, there are 10.9 million job openings in the U.S., compared to about 5.8 million unemployed individuals. Moving forward, a swift reduction in job openings is anticipated, with the creation of new jobs projected to range between 200,000 and 300,000 monthly for the next several months. This exemplifies a full-employment recession: an economy in downturn yet maintaining full employment levels.
Understanding Luxury Spending Trends
The high levels of luxury consumer spending observed in the early stages of the recession can also be rationalized. While nominal consumer spending appears to be increasing, adjusting for a 9.1% annual inflation rate reveals that real spending is actually declining.
Lower-income earners and those on fixed incomes are particularly affected by inflation, as they allocate most of their disposable income toward essential goods, leaving little for other expenditures. As prices rise, their purchasing power diminishes, exacerbating the recession's impact. Consequently, they become more cautious about spending on non-essential items.
Higher-income earners, while also facing increased costs for necessities due to inflation, often choose to reduce their savings rather than curtail their non-essential spending. During prosperous economic times, these individuals typically save a considerable portion of their income, allowing them to respond to inflation by spending more freely to uphold their lifestyles.
It's important to note that changes in luxury consumer spending generally lag behind broader economic trends, so a downturn in spending may not occur until well into a recession.
This recession marks the first instance of a full-employment recession in the U.S., coinciding with a significant labor shortage in a non-war context. The recession of 2022 stands as yet another anomaly, layered on top of the unique challenges posed by the pandemic from 2020 to 2022. It raises intriguing questions about what future economic shifts may emerge unexpectedly.