In 2008 the U.S. economy was undergoing a good deal of turmoil. In September of 2008 the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation, popularly known as Fannie Mae and Freddie Mac, ostensibly went bankrupt leaving many mortgage lenders without default insurance or a secondary market for subprime mortgages they had written and intended to sell. The collapse of these institution spread to other institutions which had purchased securities based upon home mortgages.

This collapse of financial institutions did not immediately translate into an output recession. The decline in the real GDP, seasonally adjusted, as estimated by the Bureau of Business Analysis of the U.S. Department of Commerce declined by about 1.6 percent between the third quarter of 2008 and the fourth quarter (Preliminary Estimate). Such a decrease would account for a decrease in employment of something on the order of 1.6 percent. However the statistics on employment prepared by the Bureau of Labor Statistics of the U.S. Department of Labor is showing a much more drastic loss of employment than one percent. There is some sort of discrepancy between the official statistics of the Bureau of Economic Analysis in the Department of Commerce and the Bureau of Labor Statistics in the Department of Labor.

Employment had been declining since the end of 2007 even though output was continuing to rise at least through the second quarter of 2008. There was a slight 1/8 of 1 percent decline in real GDP from the second quarter of 2008 to the third quarter. This is within the margin of accuracy of the GDP statistics and can easily be accounted for by the disappearance of the stimulus effect of the tax rebates which was felt in the second quarter of 2008.

There is no paradox involved in employment going down even while output is going up. This can be attributed to the increase in labor productivity. As a result of an increase in labor productivity the the same level of production can be achieved with a lower level of employment.

The levels of labor productivity over the past three decades will be shown shortly, but first it is necessary to look at the statistical record for employment.

This graph from the Bureau of Labor Statistics shows a growing level of employment interrupted periodically by a decline or plateau in employment. The average period between the troughs in employment is slightly over six years. This trough-to-trough period is made up of an average trough-to-peak period of four to five years and an average peak-to-trough period of one to two years. while not exactly cyclical (periodic) the pattern is striking.

Here is the record of total nonfarm employment since 1939.

What is notable is that in the period before 1965 the employment recessions came after shorter intervals and that the long term trend in employment growth was much slower.

The usual presumption is that job-level and employment are driven by production levels. This is not an entirely justified presumption. Consider the statistics on Gross Domestic Product (GDP) corrected for price level changes, the so-called real GDP.

The graphs of employment and real GDP generally have the same upwardly curved shape and the same recessional indentations, but a different mode of presentation is needed to see it they differ in significant details. A plot of one versus the other is needed to examine that question.

The real GDP statistics are quarterly whereas the previously displayed employment statistics are based upon monthly data. In order to make a detailed comparison of employment and real GDP the employment statistics must be put on a quarterly basis. The BLS website does not readily provide such statistics but quarterly statistics can be computed, tediously, from the monthly statistics. A plot of total employment versus real quarterly GDP has some interesting characteristics. The data for 1999I to 2008IV are shown below.

The graph indicates that there is not a one-to-one functional relationship between employment and output. If there were the graph would show employment and GDP retracing their steps along the same line when output and employment recede. Instead employment sometimes recedes while output continues to rise. Even when both are receding employment recedes a greater proportional amount than output.

The relative volatility of employment and real GDP can be seen in the following graph. The data are scaled so they change about the same graphic interval over the period 1999I to 2008IV. The data points in black are for employment and those in magenta are for real GDP.

Clearly it is not short term fluctuations in output that are determining short term fluctuations in employment.

Apparently the short term fluctuations in employment are driven on the downside by the closing of businesses that are proven to be of marginal viability. Once there is the perception that business is not going to get better the owners decide to fold up. The loss of jobs may also be due to competition in markets. When new retailers enter a market their employment adds to the total for that market. When new or other retailers fail as a result of the competition their employment there is a reduction of employment. This phenomenon would even include the case where there is no existing competition such as an entrepreneur trying to create a new business that just cannot make it.

Trends in employment can be influenced by the growth in labor productivity. Plotted below is the ratio of real GDP to total employment. This does not take into account hours worked so it is not a precise measure of labor productivity.

What is most obvious from the above data is that there is a long term upward trend in productivity. Such a trend may come from improved physical equipment available for employees, improved work techniques, shifts in the distribution of employment from lower labor productivity industries to higher productivity ones. Because the total employment was used for the calculation rather than hours of work the computed labor productivity would be influenced by the average hours of work. A separate, more detailed study of labor productivity is needed. However, what is clear from the above graph is that there was a significant increase in labor productivity around the year 2000. There is significant rise in productivity above the trend starting about that time that has continued. This factor in itself could account for the weakness in employment growth in the period 2000-2008.

The Financial Crisis of 2008 and the Employment Recession

Although there was an employment recession in 2008 dating back to the first of the year the financial crisis of September changed the economic situation quite drastically. Here is the record of total nonfarm employment for 2008 as compiled by the Bureau of Labor Statistics.

Employment is seen to be declining rather regularly from January to August. Then comes September and the declines accelerate significantly. This is displays more vividly in the form of the month-to-month proportional changes.

For January to August the rate of decline in employment was about 0.1 of 1% per month. After September the monthly rate of decrease moved to a level of 0.5 of 1%. This is a five-fold increase and the rate of decline as a result of the September 2008 financial crisis. Clearly this is a much more significant factor than whatever had been developing since December of 2007. For more details on the nature of the financial crisis of September of 2008 see Subprime. After March 2009 the rate of decrease declined from about 0.5 ot 1 percent per month to roughly 0.3 of 1 percent per month. This is a reduction in the severity of the decline but it is still a decline. The employment recession is still in effect.

Here are the numeric details for the previous graph.

The most striking thing about the graph of the monthly percentage changes in employment is the regularity of pattern. It is almost like clockwork; a movement to a particular level, then an uptick and then a downtick. The amplitude of the variations from a constant level is constant. To see how startling this regularity is compare it with the pattern for the previous two recessions.

For these employment recessions there was a period of erratic decline followed by a period essentially no change but with erratic small fluctuations and then the recovery, a period of erratic positive growth rates in employment. What a contrast!

Investment in Plant and Equipment

In past recessions it was a decline in private investment that produced the recession. In the recession of 1929-1930 that led to the Great Depression of the 1930's real private investment collapsed by about 90 percent. In the postwar recessions there was always a decline in real investment that produced the recession and a recovery of real investment that ended the recession.

For example consider the 1974-1975 recession.

A similar pattern was seen in the 1982 recession produced by the anti-inflation tight money policy of the Volcker Fed.

Although the ultimate cause was the tight money policy the effect of this policy was manifested through its effect on private investment which in turn produced the recession.

In contrast consider the statistics on private investment in the most recent times.

There the problem was clearly the decline in residential construction investment. This was not a recent development. Residential construction investment has been declining since the last quarter of 2005. There is also a problem with the decline in inventory investment culminating with a net sell-off of inventory in the last quarter of 2007. Net inventory investment goes through some radical fluctuations and the upward fluctuations offset in the recent past the decline in residential construction. Now the down fluctuations in inventory investment are coinciding with the declines in residential construction.

In previous recessions the source of the problem was a decline in the purchase of equipment and other investment goods. In these current circumstances the level of business investment in plant and equipment was not declining before the third quarter of 2008. It declined only after a barrage of pronouncements that the economy was in a recession and that it was going to to a long one and hence any company that continued to increase its productive capacity would be foolish. Thus in this situation the decline in the production and purchases of automobiles and residential housing was used to induce fear out the part of businesses.

The recession is now real but it was induced by the barrage of pronouncements that the economy was in a recession and that it was going to to a long one. Why was there such insistance that the economy was in a recession long before there was any recession in production. One element was a media hatred for George W. Bush and an obsession with regime-change. Anything that what would destroy the record of the the Bush Administration and help replace it with a Democratic Party regime was looked upon as good, even if it was bad for the country. Crying Recession would not necessarily change the expectations of businesses and their investment plan. It took the dramatic event of the bankruptcy of Fannie Mae and Freddie Mac and the chaos in the financial markets which followed to lend credibility of the pronouncements of recession.

Given the crucial role that the collapse of Fannie Mae played in the current recession its placement in September when it would have maximum electoral impact is suspicious. Is it possible that Fannie Mae went bankrupt months before and the announcement was postponed until September? This would have been a terrible thing, but the truth is far worse. Fannie Mae was not bankrupt in early September. Its assets were not less than its liability. Its stock was trading on the stock market. However Fannie Mae's management chose to declare it bankrupt and asked to be taken over by the Federal Government.

This event, precisely because it was unexpected, produced panic in the stock market. Just as there can be irrational exuberance in a bubble there can be irrational panic in the market. In both cases the irrationality creates a self-fulfilling prophecy. The collapse in stock prices then produces consternation among consumers when they see the loss in value of their stock holdings.

It is clear that Barrack Obama had foreknowledge of the impending financial collapse. When John McCain asserted that the economy was basically in good shape Obama announced that McCain was not up to date. The official statistics confirmed McCain's assertion. It is not surprising that Obama knew about the impending collapse before hand. The political candidate receiving the second largest amount of campaign contributions from Fannie Mae was Barrack Obama. (The first was Christopher Dodd of Connecticut, who has long been the most important supporter of the insurance industry in the Senate.)

Fannie Mae would have eventually collapsed but some savings and loan associations operated for years in a state of bankruptcy. Usually it is the creditors that have a financial institution declared bankrupt. What a suspicious situation in which the management declares that their institution is bankrupt before it is bankrupt!

Remedies

One strategy for ending an employment recession is to try to pump up aggregate demand. This is basically what the Administration is attempting in the Stimulus package (aside from creating a massive political pork barrel). Because the employment recession did not have its origin in an output recession this is likely to have disappointing results. There is an output recession now which started with the financial crisis associated with the bankruptcy of Fannie Mae and Freddie Mac. (The erroneously declaration of the NBER and the media that the U.S. was in an output recession may have contributed to creating an output recession.) The output recession is relatively small compared to the magnitude of the employment recession so curing the output recession is not likely to do much about the employment recession.

Some of the employment recession is simply the sloughing-off of enterprises which have been found not to be economically viable. Some is from the scaling back of operation that have been expanded to excess such as the Starbucks foo-foo coffee houses. Nothing can be or should be done about saving those jobs. The only thing that can be done is allow entrepreneurship find new enterprises which are economically viable, which means reducing the burdens on entrepreneurship such as taxes and regulations.

Other job losses such as in the automobile industry require a different strategy. The automobile industry's troubles lie in excessive prices for the standard model in the face of its likely to soon be obsolete. The autoworkers' union was able to use its power to basically price the American autoworkers out of the market. Until that situation is remedied there is little hope for jobs in the American auto industry. The American steel workers faced the same cold logic of globalization in the past.

A big share of job loss has to do with productivity increases rather than decreases in output. One remedy for the loss of jobs in the case where there is no output recession is to restructure employment by shifting to a shorter work week. The U.S. economy fared well under the creation of the 40 hour work week. It is now likely that something on the order of a 30 hour work week should be instituted, perhaps fewer work days rather than shorter workdays. This restructuring of employment is something long overdue in America. European workers have had a reduced work week compared to America for decades. It won't be simple and it won't be easy but its time has come.

The big problem is how to restore the confidence of businesses that the economy will be growing and that there will soon be a need for increased capacity. It might help if the Administration admitted that there was no real basis for its pronouncements that the economy was in a crisis of unprecedented proportions. All of the other measures may likely have more of a negative effect than a positive one. Franklin Roosevelt and the New Deal thrashed about trying to stimulate the economy but only prolonging the Great Depression for ten years. This happened because the Roosevelt Administration while trying to encourage business simultaneously created uncertainty about the future which offset the stimulus measures. If a business is worried about possible nationalization a few years down the road it is not likely to invest in new equipment even if the interest rate is reduced. The Obama Administration is also creating a similar uncertainty about what the economic system of the United States will be a few years from now. Government micromanagement is very discouraging to businesses which are contemplating risky investments.

(To be continued.)