U.S. Review
The Recovery May be as Challenging as the Recession
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This week’s economic numbers were generally disappointing, particularly given the growing consensus that the recession ended around mid-year.
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The cash-for-clunkers trade-in program boosted retail sales but overall sales still declined as consumers cut back on just about everything else.
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Productivity growth surged and inventories dropped sharply, confirming anecdotal reports that businesses cut costs every way they could earlier this year. Cost cutting should remain in place for the next year or so.
Two Steps Forward and One Step Back
We believe the recession ended around the middle of this year. The ending of the recession is more significant to economists and statisticians than it is to ordinary citizens, however, most of whom will see little difference in their day-to-day lives. Unemployment remains high, incomes are basically stagnant, and consumers and businesses remain very reluctant to spend and invest. The end of the recession simply means that things are no longer getting worse and may in fact be starting to get slightly better. In layman’s terms, we have gone from taking two steps back for every one step the economy took forward to taking one step back for every two steps the economy moves forward.
This past week’s economic reports came in slightly below expectations but remain consistent with what you would expect to see near the end of a recession. Nonfarm productivity surged at a 6.4 percent annual rate during the second quarter as businesses slashed hours worked much more than they slashed production. Hours worked tumbled at a 7.6 percent pace during the quarter, while nonfarm output declined at just a 1.7 percent pace.
The sharper drop in hours worked has raised hopes that businesses may have cut employment and hours too much and will be quicker to ramp up both once demand revives. We are not sure this argument holds up. Nonfarm productivity growth is no stronger than it was at the tail end of the 2001 recession, which did not see the unemployment rate top out until 19 months after the recession ended. Year-to-year nonfarm productivity growth is actually lower today than it was back in 2001, which suggests businesses may try to squeeze out even more efficiency gains in coming months. Moreover, productivity in the manufacturing sector actually declined during the second quarter and remains much lower on a year-to-year basis than where it was at the end of the past two recessions.
Manufacturing productivity should get a boost from a revival of motor vehicle output in the third quarter. Output turned up sharply at the start of July and is set to nearly double from is second quarter average. The July industrial production figures show output of motor vehicles and parts rising 20.1 percent during the month. Hours worked rose 12.0 percent, so productivity will certainly get a boost. Aside from the pick-up in motor vehicle output, however, industrial production was actually down 0.1 percent. Most of that drop was at utilities, which saw production slide 2.4 percent, reflecting less demand for electricity amid this summer’s unusually mild temperatures.
Retail sales were another piece of disappointing news. Cash-for-clunkers provided a huge boost, resulting in a 2.4 percent rise in sales at motor vehicle dealers. Excluding motor vehicles, however, sales declined 0.1 percent, with declines spread across nearly every key sector. Moreover, the key core measure of retail sales, which excludes motor vehicles, gasoline and building materials, fell 0.2 percent, marking the fourth drop in the past five months. The weak showing casts some doubt on forecasts for a rebound in consumer outlays during the third quarter.
Global Review
Indian Economy Shows Signs of Acceleration
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Like many of its Asian neighbors, the Indian economy is showing signs of acceleration. Although exports remain depressed at present, strong auto sales suggest that Indian consumer spending is alive and well.
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However, the Indian economy is not completely out of the woods yet. The potential for a monsoon that does not bring enough rain is one of the biggest downside risks that the economy faces at present. The agricultural sector accounts for more than 15 percent of GDP, and a downturn in agricultural output that a bad monsoon could cause would slow overall economic growth again.
We have been writing recently that many Asian economies are showing bona fide signs of recovery. If there were any doubts about recovery in the Indian economy, they were put to rest this week when data showed that industrial production shot up 7.8 percent (year-over-year) in June, which was much stronger than most investors had expected. Even if the volatile monthly numbers are smoothed with a 3-month moving average, the upturn in industrial production growth is unmistakable (see graph on the front page). Add India to the list of Asian economies that are recovering from their recent slowdown.
From where is the upturn emanating? Statistics on overall retail spending are not readily available, but the 11 percent rise in car sales in the second quarter relative to the same period last year suggests that the consumer is alive and well. Indeed, production of consumer durable goods, which includes automobiles, jumped 15 percent in the second quarter, helping to fuel the overall rise in industrial production recently. Unfortunately, exports remain depressed, with the overall value of exports down 30 percent in the second quarter on a year-over-year basis. However, the rest of the world is showing signs of economic stability at present, which should lead to rising Indian exports in the months ahead. Everything else equal, industrial production should strengthen further.
But is everything else equal? Are there any factors that could cause the economy to weaken anew? Yes, and the most visible factor is well beyond the control of policymakers. Namely, the annual monsoon has not been very good so far—rainfall is about 20 percent lower than normal—and the effects on the overall economy of a monsoon that does not bring adequate rain can be noticeable. For example, the 2002 monsoon was unusually bad, and it caused agricultural output to decline more than 10 percent in late 2002. Consequently, the year-over-year rate of overall GDP dipped to less than two percent in the fourth quarter of that year (top chart). Although the monsoon typically lasts through September, it will be difficult to realize a normal season this year due to the slow start to the rain over the past two months.
Over the past few years the correlation between agricultural output and real GDP growth has become less tight as the non-agricultural sectors of the economy have boomed. However, the agricultural sector still accounts for more than 15 percent of Indian GDP, which poses significant downside risks to the overall economy should the monsoon not bring enough rain. With the economy not completely out of the woods yet, the Reserve Bank of India (RBI), which has guided short-term interest rates significantly lower since last summer, is likely to keep policy accommodative for the foreseeable future. And with wholesale price inflation, which is the benchmark inflation gauge in India, still in negative territory, the RBI has the luxury of remaining in wait-and-see mode for some time. If the monsoon passes without significant negative effects on the economy, then the RBI will slowly start to withdraw policy support in late 2009/early 2010. We have been writing recently that many Asian economies are showing bona fide signs of recovery. If there were any doubts about recovery in the Indian economy, they were put to rest this week when data showed that industrial production shot up 7.8 percent (year-over-year) in June, which was much stronger than most investors had expected. Even if the volatile monthly numbers are smoothed with a 3-month moving average, the upturn in industrial production growth is unmistakable (see graph on the front page). Add India to the list of Asian economies that are recovering from their recent slowdown.
