Unemployment impact

How much will a high rate of unemployment impact the overall economy? The answer to that depends on two factors. First, assuming that the unemployed will have some sort of income, whether from Government, benefits, retirement funds or perhaps "off the books" work, that will offset the loss of employment income to some degree. Of course, the amount of Government aid they get impacts taxes. The second factor is the ability of businesses to be profitable if you subtract the loss in disposable income, the first factor, from the economy.

I haven't seen very much information on the actual reduction in income suffered by an unemployed individual, and anything I come up with here is clearly speculative, but lets assume they lose 2/3rds of their income. I actually think that between retirement funds, Government aid, part time work both on and off the books, they will actually do better than this but I need to use some number. Well, if we were to have a long term unemployment rate of 10%, and nothing else was to change, we would see a 6.6% decrease in disposable income from unemployment. Now of course, you have to subtract the unemployment rate that we had prior to the downturn and lets use 4%. So instead of 6.6% we have a net decrease of 4%. Clearly, a factor and there are other factors that may very well mitigate that impact but lets use that.

So if high unemployment led to a reduction in consumer spending of 4% what does that mean for the economy? I guess it depends on you view of what a recovery is going to look like. Considering other factors in the economy, such as loss in housing and equity wealth and increase in savings it would potentially lead to a smaller economy of about 15%.

Now if the economy was about to contract by 15%, this would be quite scary. However, the economy has already contracted by more than that and is now in fact starting to recover a bit. What we are seeing is company after company reporting earnings that support a contraction to a lower need for revenue in order to maintain profitability.

A number of analysts or bloggers seem to think that cost reduction is a one time event and try to discount it. However, when a company reduces cost by laying off workers or closing plants, this is an ongoing reduction. The savings keep on helping profitability. So if a company has adjusted its operations to be profitable at a certain reduction in revenue and revenue then grows, the improved profitability actually may lead to greatly increased profits.

So, as we watch what may very well be, at least initially, a jobless recovery, how bad is it for the economy? On an ongoing basis, I think it will lead to about a 4% reduction in economic activity and consumer spending. Without ignoring the individual devastation that losing a job can cause, from a purely economic impact it becomes a fairly minor overall factor in economic recovery.

Recovery?

We are starting to hit the period of time when the stimulus package is going to start having a bigger impact. Whether the stimulus was properly targeted or implemented speedily enough, there will be many projects kicking off now that will show some improvement in employment.

Also, with GM and Chrysler out of bankruptcy and some increased demand in the auto sector, we can expect to see a small bounce as the auto companies and their suppliers start working on the fall lines.

Also, as many of the companies have cut to the bone in order to preserve profits, I would think that the production for the Christmas season has to create some jobs in manufacturing as well.

We also see a bit of a rush to get houses started so they qualify for Government credits and we should see a small uptick in construction employment.

All of this indicates that we are either at the top or very near the top of our unemployment curve.

Now many analysts are predicting unemployment to continue to grow into early next year, and if retailer's overstock for Christmas we may have a subsequent problem, but assuming they gear u for a modest but profitable season we should start to see the stability in employment that we need to renew GDP growth.

Housing is a tougher problem, but I do think that a larger number of people who have moved in with parents and/or relatives and have been saving, will with an improved employment outlook, use that savings to invest in some of the most affordable housing they will probably see in their lifetimes.

Starting to smell more and more like recovery.

Indicators

Then can be little doubt as we look at the economic numbers that the leading edge economic indicators are starting to point up a bit. Yes, while Intel posts great results, a company like Dell doesn't. This simply indicates the differences that will always exist between strong, innovative companies and companies that fail to adjust to changing situations.

This certainly doesn't mean that there still won't be bad news. It is going to be a while before successful companies hire enough to offset the reductions from failed companies. Now, I see some commentators trying to spin unemployment into a leading indicator. It isn't and never will be. All business corrections involve weak or inflexible companies going out of business. One of the reasons they are weak is that they have too much cost. Successful companies will grab market share as this happens, but thanks to the fact that they were already more efficient and the synergies related to increased market share, the people let go by the failed companies will not be absorbed completely by the surviving companies. Further, weaker companies that see the light, shed employees to save costs. So it takes either a new growth industry or growth past the prior level to reabsorb all the employees unless efficiencies decline.

Now the companies that make money during a correction do so by reducing cost and possibly picking up market share. The market share they pick up may offset the reduction they would have seen in their own revenue but it is unlikely to push revenue up until later in the cycle. When growth returns, they are poised to have great improvements in earnings.

If you are a long term investor, this is still a wonderful time to get in at what will look like lows in the fall.

American ingenuity

When you read certain news articles or watch certain commentators on TV, you find a lot of clear black and white views. One of the things that I think is overlooked is that most people when faced with a problem, actually try to do something about it.

Now, in an economy we have a broad spectrum. I will admit that there are a certain number of people, for whatever reason, who effectively fall off the cliff. You see them living in boxes, or under boardwalks. Many of these people have either mental or addiction issues and the status they find themselves in is normally not temporary. However, the vast majority of Americans who run into economic difficulties, say the loss of a job, do not join these ranks.

So what happens to them? They find some way to cope. First, there are things like unemployment insurance and after that runs out, other forms of assistance available. Further, in many of these families, there are multiple earners, so possibly there is still at least one income. The people who are out of work strangely often show a significant amount of ingenuity, such as doing odd jobs, possibly getting seasonal jobs and often these activities are part of the underground economy. As part of the underground economy, this activity is completely outside of normal economic measures. Of course there is the other underground economy involving drugs, gambling and prostitution and the amounts generated there shouldn't be ignored. However, more benign in many ways are those who work on an irregular on-call basis for things like movers, landscapers, painters, etc., who basically get paid "off-the-books".

I don't have a good way to estimate the level of this activity, but I have some anecdotal evidence that it is quite prevalent. Obviously, it is hard to measure, since there is no reporting either by the employer or the employee.

Another way people cope is by selling things. If you have been laid off and happen to have a fairly new big screen TV, you can use either on-line sales or word of mouth to pick up some needed cash to help you cope. Obviously, this sort of activity is also very much under the radar and hurts retail sales since the person getting the TV this way, doesn't go to Best Buy to get one. How much do these sales equal? Once again, I have no way of knowing, but it certainly seems that sites such as E-bay and Craig's list are booming.

Of course another way people cope is to do things themselves that they use to hire people to do. Now, this isn't considered economic activity per se, but if someone used to pay $50 a month to have a landscaper come in and now does that themselves, after buying some materials and tools from Home Depot or Lowes, effectively it increases their ability to pay a mortgage, or to buy other things.

I could go on but one of the things that shouldn't be overlooked is the ability of the Average American to find a way to "get by." Yes, it doesn't help the numbers, but it does mitigate the pain and provide a base of economic activity that is usually ignored by the prognosticators.