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Jobless Claims Soar, Economy May Be Headed for Second Recession: Rising Gas Prices, Deficit Woes Cast Shadow on Jobs Outlook

Prof. Peter Morici - 5/5/2011

The Labor Department reported today new unemployment claims rocketed to 474,000 last week, indicating the recent uptick in hiring may be ending. It appears the economy slowed further in April, as rising gas prices took a bite out of consumer spending, and the lack of resolve to deal with federal budget woes is curbing businesses appetite for risk taking and hiring.

Economists expect the Labor Department to report tomorrow that 185,000 jobs were created in April, but if the report comes in that strong, it may be the last good reading for some time. First quarter GDP growth was a disappointing 1.8 percent, and many businesses can easily accommodate modest growth in demand by increasing productivity.

Growth at less than 2 is difficult to maintain because productivity advances about 2 percent a year. Business in sectors with below average growth in demand lay off workers, which results in reduced spending and further layoffs. Such a negative cycle would result in second recession.


Indeed, the four week moving average for new unemployment claims moved up to 408,000 for the week of April 23 from 390,000 the week of April 2—a rate below 350,000 is consistent with a strong economy and above 400,000 is perilously close to recession levels.

Without stronger growth in the second quarter, the economy will cycle down into recession—it can’t likely continue to drag along at about 2 percent.

Outlook for Second Quarter Growth

For the second quarter, the glass may be half empty or half full, depending on perspective.

Gas prices continued to surge in April and May, and initial private surveys of chain store activity indicate higher gas prices dampened Easter spending—we will get a clearer picture on May 12, when the Commerce Department publishes preliminary April retail sales.

The housing market remains a drag and the full impact of the earthquake in Japan will not be felt until the end of May. Health care costs continued rising, eroding purchasing power, and state governments are taxing more and spending less.

On the positive side, commercial construction should rebound, defense spending will pick up and exports should get a lift from a weaker dollar. The auto sector is exhibiting remarkable strength—GM is boosting market share and Ford technology is commanding premium prices.

Overall economists are expecting growth in the range of 3 to 3.5 percent—but they had similarly strong expectations about the first quarter in January. However, economists have had difficulties assessing the full consequences of rising gas prices, erosion in market shares from surging Chinese exporters, the budget woes in Washington and the state capitals, and festering sovereign debt problems in Europe.

Stay tuned—weather will be warmer but that is about the only certain forecast for the second quarter.

Importance of Core Private Sector Jobs

Until February, the private sector was creating few permanent jobs. Most jobs were either in health care and social services, which enjoy heavy government subsidies, or temporary business services. Excluding those activities, the “core” private sector gained 183,000 and 157,000 jobs in February and March; whereas during the prior 13 months, the average gain was only 47,000.

Core private sector jobs have the potential to set off a virtuous cycle of hiring, consumer spending and more hiring, but after such a deep recession, 170,000 jobs per month is simply not enough.

The economy must add 13 million private sector jobs over the next three years—360,000 each month—to bring unemployment down to 6 percent. Core private sector jobs must increase at least 300,000 a month to accomplish that goal.

Growth at three percent will only keep unemployment steady, because the working age population increases one percent a year, and productivity advances about two percent. Growth in the range of 4 to 5 percent is needed to get unemployment down to 6 percent over the next several years.

Prior to the turmoil in the Middle East, economists were forecasting 3.5 percent growth for 2011, but the surge in oil prices and gasoline to $4.00 per gallon will shave up to one percentage point from that outlook. For the entire year, growth in the range of 2.5 percent would be right on the razor’s edge of what is sustainable without the economy tumbling into recession from additional layoffs.

Structural Impediments to Growth

The U.S. economy and the durability of American prosperity are too vulnerable, because temporary tax cuts, stimulus spending and large federal deficits do not address structural problems holding back GDP growth and jobs creation—the huge trade deficit, dysfunctional energy and tax policies, and rising health care costs are the culprits.

At 3.3 percent of GDP, the $500 billion trade deficit is a tax on domestic demand that erases the benefits of tax cuts. Consequently, the U.S. economy is expanding at about 3 percent a year instead of the 5 percent pace that is possible after emerging from a deep recession and with such high unemployment.

Oil and trade with China account for nearly the entire U.S. trade deficit.

The Administration is banking on electric cars and alternative technologies, such as wind and solar, to replace imported oil but those won’t pull down gasoline consumption enough to reduce enough the oil import bill for the balance of this decade. Failure to produce more domestic oil and gas, by sending dollars abroad for imports, is a jobs killer.

China maintains an undervalued currency by purchasing about $450 billion in foreign currencies each year—this reduces domestic Chinese consumption and subsidizes Chinese exports by about 35 percent. Failure act to offset Chinese currency subsidies, for example by taxing dollar yuan conversions, is the single most significant flaw in Administration policy to create an adequate numbers of jobs.

More broadly, major trading partners in Europe and Asia rely on value added taxes to finance government and health care, whereas Americans pay higher corporate taxes and directly for health care. Under WTO rules, VATs are rebateable on exports from Europe and Asia and are applied on imports from the United States into those markets, creating huge pricing disadvantages—American products are essentially taxed twice. A neutral change in U.S. tax policy toward a VAT—swapping a VAT for reductions in corporate and personal income taxes—would help remove a major competitive disadvantage on U.S. exporting and import-competing industries.

Finally, the 2010 health care law is pushing up health care costs, rather than reducing those as promised, making insurance unaffordable for many small and medium sized businesses. Although manufacturing has enjoyed a stronger recovery than the rest of the economy, it has been significantly focused on activities that use very little labor illustrating the burden that health care imposes on U.S. employers.

The recent Standard & Poor’s warning that U.S. debt may lose its AAA rating was more than a statement about the political gridlock in budget negotiations. U.S. debt problems will ultimately require more robust growth in employment and tax revenues and require Congress and the President to revamp energy, trade, tax, and health care policy. Without those, the American economy cannot succeed.