Strong firms lead jobless recovery
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Markets fear a double dip as American housing data disappoints and China cools, but companies are in good shape and expanding their workforces, which is crucial to sustaining the recovery.
After little more than a year of recovery, markets fear that the world economy will experience a double dip and go back into recession. Equities sold off, while the yield on 10-year American Treasury bonds broke below 3%. Cyclical companies, which had been driving the recovery in the American and European equity markets, pulled back as investors questioned the growth outlook.
For those who saw the recovery as little more than a policy-induced boost, such concerns come as no surprise. Fiscal policy could only provide a temporary offset to the downdraft created by deleveraging and repair of the financial system. Now that policymakers are making plans to withdraw support, as endorsed at the recent G20 meeting, the weakness of global demand is back in focus.
Recent economic data offers little comfort. The American housing market, so often an important engine of recovery, remains flat and continues to experience an Lshaped profile after giving back all the gains made earlier in the year when tax incentives boosted sales. Similarly, the latest American employment report showed a fall in payrolls, as census recruiting fell back and private sector job growth remained sluggish. (article continues below)
Meanwhile, the crisis in the eurozone raised doubts about European growth as governments accelerate fiscal tightening to placate markets and ratings agencies. Even China, which had seemed immune to growth worries, is showing signs of cooling after rapid growth over the past year.
In line with these developments, the widely followed manufacturing Purchasing Managers indices (PMIs) weakened and our activity indicator for the G3 - America, Germany and Japan - rolled over.
While recognising that the global recovery is moving down a gear, it is useful to step back and look at the dynamics of the upturn so far. Recent developments represent an end to the first stage of the recovery, where growth is driven by the inventory cycle as companies bring inventories back into line with sales, having slashed them during the recession. For example, in the year to the first quarter of 2010, inventory changes accounted for 1.4 percentage points, or half the 2.4% rise in American GDP.
Such an outcome is typical of the early stage of any recovery, but as the boost from the inventory cycle begins to fade, the challenge for the world economy is to sustain growth from other sources. Activity will have to be driven by stronger final sales which, given the move toward fiscal austerity, means stronger private consumption and investment spending.
How well placed is the private sector to meet this challenge? The key lies with companies. Of particular note is the significant improvement in the corporate sector’s finances, which swung from deficit to surplus as profits recovered. Those companies that survived the worst downturn for 50 years are in good shape and are in a position to begin spending again.
One sign that this is already happening can be found in increased spending on capital equipment where orders have picked up sharply around the world. After slashing capital expenditure (capex), businesses in America, Asia and Europe have started to invest again. American business investment rose at a double-digit rate in the first half of this year and should match this over the next six months.
Importantly, there are signs that companies are recruiting again. Anaemic payroll growth led to the upturn being termed a “jobless recovery”. However, recent developments could be described as a productivity miracle. “Less is more” would seem to be the mantra as firms raised output with fewer workers. American employment is still 2% lower than in the first quarter of last year, even though real output is more than 2% higher.
Such a performance has driven the upturn in corporate profits and is likely to continue through 2010. Nonetheless, there are limits to how far companies can squeeze their workforces and employment is likely to rise more closely in line with output in the second half of 2010 and into 2011. Higher employment is critical as it would boost incomes, thus enabling households to increase their expenditure.
In short, private spending should be sufficient to keep the global recovery on track. However, there are risks to this outlook. It relies on the corporate sector to pull us through the next phase of the recovery, yet business spending is driven by animal spirits and if chief executives decide they would rather wait another six months before implementing plans to increase capex or recruitment we could be in for a difficult period. Overall though, business should hold its nerve and this should be the end of the beginning for the recovery, rather than the beginning of the end.
