The attacks in Paris on November 14 could have a significant effect on the world economy going forward. Geopolitical factors played a role in the Federal Reserve’s initial decision not to raise short-term interest rates in September. There is also the concern that both businesses and consumers will reduce their spending until they become more confident about future world stability. Finally, with Daesh striking targets beyond the Middle East, a major coordinated military effort might has been organised to subdue its forces in the Middle East.
The attacks by Al Qaida on the World Trade Center in New York and other sites in 2001 were not followed by a series of incidents although there was widespread fear of further strikes at the time; the resultant escalation of security precautions proved effective. The US equity market declined sharply in reaction to those assaults, but a month later, with world economies recovering from a recession, the indexes had recovered their lost ground. Nonetheless, the market rallied on the Monday after the Paris attacks, even though the economies of the major developed countries have been showing weakness recently.
Before the Paris carnage there was some good news in the US We finally got a strong jobs number for October with a 271,000 increase in nonfarm payrolls. Construction was the standout among sectors adding workers. The Federal Reserve raised short-term interest rates last month. And average hourly earnings increased 2.5 per cent on a year-over-year basis, with many observers commenting that wages were “accelerating.” Fed Vice Chair Stanley Fischer has argued that if productivity is not growing, “there is not a lot of force in the economy for real wages to rise.” So perhaps wages won’t “accelerate.”
Goldman Sachs has identified three factors influencing their “wage tracker.” The first is labour market slack, which has depressed growth 0.6 per cent, according to their estimates. The second is weak productivity growth, which has diminished wage growth by an estimated 0.3 per cent. The third is low inflation, which has dampened wage growth by an additional .2 per cent. Adjusting for these factors added together would produce wage growth of 3.2 per cent, 1.1 per cent above the current level, using their data. Recent business cycles have shown wage growth of 3.5 per cent to 4 per cent, so what is holding wages back?
The slow growth of the economy is clearly one factor. The Goldman estimate that the economy is growing about one percentage point below potential seems right to me and accounts for about half of the shortfall in wage gains. In the 1950s it was not uncommon to have productivity growth in excess of 4 per cent. In the 1960s 3 per cent was a frequent reading, but after the period 2000 to 2005 where productivity growth was 3 per cent to 4 per cent, recent data has shown 1 per cent. The recovery cycles of previous periods have been characterised by forces that increased productivity.
Looking ahead, I examined opposing views of productivity. One bearish view is espoused by Frank Veneroso, an economist whose work I have followed for twenty years. Veneroso starts with the statement that productivity growth in this cycle has been abysmal, averaging only 0.5 per cent over the last five years. He sees no reason in history or theory for it to change in what he views as a mature economic expansion. In eight of the ten cycles since 1950 there has been a surge in labour productivity in the early part of an expansion and decay in the latter part. One of the exceptions was the 1990s, when capital equipment investment in technology caused a late cycle increase in productivity.
According to Veneroso, valuations in the technology sector may be reaching an extreme point, particularly for promising companies that are not yet public. Businesses have been using leverage to increase earnings per share and borrowing has been expanding at almost twice Gross Domestic Product growth, thereby putting business debt at an all-time high. Mergers and acquisitions, share buy-backs and leveraged loans are approaching the 2007 peak. This data suggests that the headwinds are not impeding entrepreneurial activity and innovation so there is no reason to expect a significant gain in productivity.
If the low productivity numbers are real and not a result of measurement error, they are significant. If productivity does not improve, the implications for the future economic outlook are worrisome.
The equity market is very much aware of the benefits of producing profits with relatively few employees. Some of the best performing stocks have a very high enterprise value to employee ratio. According to Strategas Research, examples include Facebook with an enterprise value (EV) of $285 billion and 9,200 employees, for a ratio of 31, Visa with an EV value of $185 billion and 9,500 employees and a ratio of 20 and Netflix with an EV of $46 billion, 2,450 employees and a ratio of 19. We have transitioned to a knowledge-based economy where the computer plays an important role from a manufacturing economy where labour was key to output.
In terms of productivity, assessing the impact of technology is hard. There is no question that the cell phone and the computer have made us more productive. Many of us can work effectively away from the office in any location and some of the new, innovative companies like Uber and Airbnb have productivity characteristics that are probably not accurately reflected in the reported statistics. What we do know is that thousands of jobs in manufacturing and services have been eliminated by technology. This has resulted in favourable productivity figures over the last fifty years and sent profit margins to an all-time high, allowed the stock market to recover and increased the perception of inequality. Both corporate profitability and the standard of living are tied to productivity. If productivity is being properly measured and is, in fact slowing, it will have a profound impact on the future outlook for the economy and the financial markets.
Byron Wien is the vice-chairman of Blackstone Advisory Partners LP.
