It Depends

One of the current success stories of late for Rhode Island has to be retail sales. Not only has retail sales been in a well-defined uptrend since the last quarter of 2009, at the present time it is very close to its highest level since 1990.

Retail sales can be either a coincident or lagging indicator, meaning that it either reflects what is going on at the present time or what has recently occurred. For Rhode Island, the most timely data on retail sales is that for retail sales subject to the sales tax. Based on when these taxes are paid and recorded here versus when the sales actually took place, retail sales for Rhode Island is a lagging indicator. Also, retail sales is a very cyclically sensitive indicator, which means the value of retail sales is very sensitive to the overall level of economic activity. The technical term for this is that retail sales are pro-cyclical, since they move in the same direction as the economy.

Like any economic indicator, it too has its limitations: since this is based on retail sales tax collections in Rhode Island, it excludes any items that are not currently subject to taxation, most notably clothing. And there can be distortions. For example, given the very mild winter, winter clothing expenditure very likely fell since the same time last year. If that decline was sufficient to move total retail sales lower than they were last year, the understatement from excluding clothing sales from our sales tax data might not be as large as it typically is. Similarly, since the meals tax in Rhode Island has been 14.7% higher than the regular sales tax rate for several years now, this has distorted "retail sales" for meals over this period -- tending to overstate the overall total. While this may sound like minutia, it is important to understand that every economic indicator has its share of "baggage." I have believed for quite some time now that the indicator any person likes best is probably the one that person knows the least about.

Let's take a look at the historical performance of retail sales in Rhode Island, using as our basis quarterly data on retail sales subject to the sales tax expressed at an annual rate. The chart below (click to enlarge) shows values since the first quarter of 1990. Please note that the vertical axis is stated in logarithms, mainly because a given vertical distance represents the same percentage (relative) change between any two period in the chart.

The most recent peak in retail sales occurred in the fourth quarter of 2006, at $12.7 billion. Can you think of anything else that happened that quarter (hint: we have discussed this numerous times in prior posts)? The answer: it coincides with Rhode Island's most recent employment peak. This reflects the fact that retail sales are very sensitive to the overall level of economic activity, as stated earlier. The trough for retail sales was in the fourth quarter of 2009, at $11.2 billion. Thus, Rhode Island's peak-to-trough decline in retail sales was 11.8 percent. Note that retail sales have trended upward throughout this recovery, although not straight up. Once again, the cyclical nature of retail sales is in evidence here.

This chart provides an excellent illustration of the mindset of most, if not all, of Rhode Island's leaders, its media, and its residents: things here have now turned around nicely, and Rhode Island is doing much better it has in a very long time. Add to this the fact that income tax revenue is up, at least above expectations, and if you read my last post, employment is apparently higher and our state's jobless rate is lower than the currently published data indicate. Thus everything appears to have returned to normal.

I agree totally with the assessment that everything here has returned to normal -- but Rhode Island's "new normal." In economics, we never look at things in absolutes. Instead, we always evaluate things in relative terms. This precludes our making substantive judgments about the behavior of indicators that are stated in current dollars, as retail sales is above. So, let's now turn to evaluating retail sales here in relative terms -- meaning relative to the purchasing power of the present time. This, recall, means examining the historical behavior of real retail sales.

The next chart shows the behavior of real retail sales subject to the sales tax for Rhode Island since 1990 (click to enlarge). As should become readily apparent almost immediately, this gives a very different picture of our current situation.

When taking inflation and purchasing power into account, the peak in real retail sales occurred in the third quarter of 2004, at $14.8 billion. This peak thus came well before the current dollar peak (in 2006Q4). Note that by stating retail sales in the purchasing power of Q1 in 2012, we are "inflating" current dollar values from earlier periods into what they would be if dollars then had the same purchasing power as today, which explains why earlier current dollar values are higher when stated in real terms. The trough in real retail sales occurred in the fourth quarter of 2009, at $11.9 billion. This is the same quarter as the trough in current dollar retail sales.

The reality of Rhode Island's current situation, our "new normal," to quote the phrase coined by Mohammed El-Erian of PIMCO, is in fact very different from the predominant view of our state's economic performance. First, real retail sales here have been falling since the third quarter of 2004, well before our most recent employment peak. Second, the peak-to-trough decline in real retail sales here was much greater than one would conclude based on current dollar values, just under 20 percent. Third, while real retail sales have improved since their trough in 2009Q4, they have registered almost no gain since that time: $12.1 billion versus $11.9 billion. Finally, the most recent trend in real retail sales is sideways to downward. Thus, Rhode Island's economy has failed to perform well enough to consistently generate retail sales growth rates in excess of inflation for quite some time now.

Where does all of this leave us? Not where almost everyone in this state appears to believe. Retail sales data, when viewed in the correct context of real values, confirms something I have written about in more posts than I care to think about, that Rhode Island is in a very tepid recovery. So, even when (or if) current dollar retail sales here exceeds it recent high of $12.1 billion, we will not have returned to anywhere even remotely close to where we once were. So, do we continue to contrast the current situation with the depths of where we once were, as seems to be the dominant view, or should we shift our focus to where we are relative to recent heights? You can guess which I will continue to opt for.

We should be attempting to move toward recent highs -- that should be the standard of excellence or satisfactory performance here. And, guess what? That outcome doesn't just fall on us from heaven. We have to work for it. And very often, this will require that we work very hard to get there. I heard a great saying a few months ago that pertains to this: "Success is not a destination, it is a journey." It's time for Rhode Island to purchase its ticket for this journey, because the dominant perspective here, to dust off an old phrase I used to use to describe Rhode Island about a decade ago, defines success in terms of "Relative Mediocrity."

Our State's Jobless Rate is Declining. Is That Good News?

In recent months, Rhode Island's unemployment has been falling. In fact, whenever the monthly labor market numbers are released, the local media focus largely, if not entirely, on the unemployment rate and how it changed. So, based on these recent declines, Rhode Island's economy must be doing noticeably better. Or is it?

First, it is critical that this statistic be viewed in relative, not absolute, terms. While Rhode Island's unemployment rate has fallen from 11.5 percent, its level from August through December of 2010, to 10.8 percent in June of 2011, it remains the third highest in the entire US! So, Rhode Island continues to be known for its beautiful beaches and its very high unemployment rate. Quite a niche, isn't it? Let me also state for the record that I don't believe that our state's jobless rate was constant over that long of a period. The single value for the entire August to December of 2010 period is doubtless the result of a smoothing procedure utilized by the US Department of Labor.

Second, we must not forget to consider the way the unemployment rate itself is calculated. To be counted as unemployed, and therefore part of the monthly statistic, an unemployed person must be unemployed (obviously), physically able to work, and this is the kicker, actively seeking employment. What that last condition indicates is that it is quite possible for the unemployment rate the fall not as the result of higher employment, as most people think has to be the case, but because unemployed persons opt to cease their active job search. In economics, this is known as the "discouraged worker effect." Actually, that's a pretty dumb name, since these people obviously aren't working and they're well beyond being discouraged. So, if an unemployed person stops actively seeking employment, that person is no longer counted as being part of the labor force, and is therefore not counted as being among the "officially" unemployed. In light of all of this, you should always view the unemployment rate and labor force participation together. Has this odd combination of declining labor force and falling unemployment been occurring in Rhode Island lately? A picture is worth a thousand words. The chart below (click to enlarge) shows these two elements in Rhode Island for the last twelve months.

Do you see a pattern here? Actually, how can you miss it? For the entire time that Rhode Island's unemployment rate has been declining (all of 2011), our state' labor force participation rate has been declining as well. Note: the labor force participation rate  (the red line in the chart above) is the percentage of our state's working age population that is in the labor force. Based on the chart above, there is definite evidence consistent with recent declines in our state's unemployment rate being at least partially related to Rhode Island residents dropping out of the labor force (as they stop actively seeking employment). And there can be strange results from the monthly Household Survey (see previous blog post on this). But this doesn't tell the entire story.

Third, there are actually two labor market surveys. The unemployment rate is obtained from the Household Survey. I won't tell you how small the sample size is for Rhode Island. This survey looks at Rhode Island's working age population and does not restrict employment to being exclusively within Rhode Island. So, Rhode Island residents working in other states are included in this survey, as are self-employed individuals. The other labor market survey, the Establishment Survey (and approximations to this by the Current Employment Survey in the short-term), focus exclusively on jobs within Rhode Island. Self-employed individuals, however, are excluded from this survey. So, given these differences, it is not uncommon for the two surveys to give different results, sometimes very different results. In recent months, survey results were noticeably different at times. Fortunately, though, the results for June were more in line with each other. Looking at recent results for this employment survey, job gains since January of this year (compared to a year ago), rose from 4,100 to a high of 9,400 in May, before declining to 8,800 in June. Throughout that time period, job loss fluctuated between 4,100 and 5,100. So, the net change in payroll employment here (what the local media inevitably reports as "new jobs" has actually been in an uptrend since January of this year. For the most recent three months, the net change in employment has been greater than 4,000. Thus, part of the reason for our state's declining unemployment rate over this period has in fact been for the "right" reason - improving employment (also see previous blog post dealing with this).

Finally, the unemployment rate is what economists refer to as a lagging indicator. In other words, its behavior this month to a large extent reflects events and trends that occurred in past months. Embodied within the way the unemployment rate is calculated is the likelihood that when an economy begins to improve, some discouraged workers will begin to actively seek employment once again. When that happens, they are once again counted as being part of the labor force and unemployed. This will often result is an increase in the unemployment rate, not a decrease, as one would normally assume when economic conditions improve. Rhode Island's declining participation rate itself is a net change of persons leaving (discouraged workers) and persons re-entering the labor force once they re-commence active job search.

So, has Rhode Island's economic performance, as summarized by the recent performance of its jobless rate been improving? Yes and no. Unequivocally! To summarize: Rhode Island's unemployment rate has been improving of late, yet it remains among the highest in the US; improvements in our state's jobless rate are not entirely the result of a better employment climate, but at least partially the result of our unemployed dropping out of the labor force.

MY REQUEST TO THE LOCAL MEDIA (an economist's pathetic plea!):
Please stop focusing so much on our state's unemployment rate, it is not a very accurate basis for portraying our state's overall economic performance. You need a much broader basis to do this accurately, such as my Current Conditions Index.

If, however, you opt to continue using the unemployment rate as your primary basis for assessing economic activity here, when you drive home after writing your story, only look in your rear view mirror for guidance the entire time (a practical example of relying on a lagging indicator). Let's see whether or not you make it home in one piece!

Rhode Island's Surprising Cyclical Strength

Although it still comes as a surprise to many Rhode Islanders, Rhode Island has been in a recovery since February of 2010. As of the time this is being written, we are approaching the one and a half year mark for this recovery.

In a number of blog posts I have spelled out precisely what a recovery means -- not a return to "normal" times, but a period where the overall level of economic activity is rising. The pace of the recovery ultimately determines how long it will take to return to "normal" times or to peak levels from the prior recovery for key indicators.


Over the past four months, employment in Rhode Island has turned in a surprisingly strong performance. On a year-over-year basis, while job loss has remained roughly constant, job gains have clearly accelerated (see blog post on this).  The result is important enough to show the following graph again here (click to enlarge).

As I was preparing monthly data for my next Current Conditions Index release, I came upon something that is also very welcome but unexpected: layoffs in Rhode Island have now fallen below their median level going all the way back to January of 2000. The next chart shows layoffs over this period (click to enlarge):

I used the median for this since the extreme values of layoffs during the last recession would push the mean significantly higher. The median, which is the middle value when all values are arranged in ascending order, will not get "pulled" higher as the mean would, so it is the preferred measure of "central tendency" here.

Three important points need to be made about the indicators reflected in these graphs. First, layoffs (actually New Claims for Unemployment Insurance), which is one of the indicators in my Current Conditions Index, is a leading economic indicator. This means that its changes today signal future movements in the overall level of economic activity. So, declining layoffs signal that Rhode Island's economy has been gaining momentum of late. Second, payroll employment overall, or its components, job gain and job loss, are coincident indicators, meaning that their changes reflect the current performance of the overall economy. From the first chart, the acceleration of job gain relative to job loss confirms what the recent downtrend in layoffs implies, that Rhode Island's overall economic performance is improving. Finally, since Rhode Island has income and sales taxes, improving levels of overall economic activity, which produce higher levels of income, result in added income and sales tax revenue. This is the basis for the recent "surprises" in tax revenue our state has witnessed.

What about the fact that Rhode Island's unemployment rate has remained stuck around 11 percent as these changes in layoffs and job gains have been occurring? While everyone pays a great deal of attention to the unemployment rate, it doesn't always move in lockstep with changes in payroll employment, for several reasons. Among other things, it is derived from a separate labor market survey, the household survey. And, the unemployment rate is a lagging indicator, so its changes now reflect what has occurred in past months. There is also a strange footnote to the way the unemployment rate is calculated: unemployed persons who stop actively seeking work are not counted as being part of the labor force, therefore they are excluded from the monthly unemployment number. The flip side of this is that when an economy improves, and some of the unemployed who had stopped looking for work begin once again to search for employment, they are now counted as part of the labor force, which tends to cause a short-term rise in the unemployment rate. However, recent declines in Rhode Island's jobless rate have largely been the result of our unemployed ceasing job search. So, it is quite possible that Rhode Island's unemployment rate might actually rise before it resumes declines based on the behavior of layoffs and job gains discussed above.

Let me point out a strange element of Rhode Island's current economic climate. Our state's jobless rate was third highest in the nation in May. Yet in spite of having so many unemployed persons here, and such a high unemployment rate, manufacturing wage growth has been very strong. While this signals recent manufacturing strength here, it also reflects the existence of skill shortages. Go figure!

Finally, at the same time Rhode Island's economy has experienced this enhanced cyclical momentum, a substantial number of structural negatives, most notably the lack of skills of our labor force, have offset some or much of this cyclical momentum. That explains why this recovery doesn't necessarily feel all that different from being in a recession.

EPILOGUE: After posting this last evening (7/7), the June payroll employment report for the US came out this morning. The results took everyone (including me) by surprise, as national employment rose by only 18,000, well below prior expectations. It will be very interesting to see the June numbers for Rhode Island when they are released in a few weeks. If they show no employment pause here, I will have to question the last few months of data here. I'll have a lot more to say on this if it actually occurs.

With Recession Over, What's Next?

Now that the US recession has officially been declared as being over, the most obvious and pressing question is where we go from here?

As there are confusions about what a recession or recovery actually means (see the previous post), there are just as many confusions concerning whether we are actually in a recovery or a recession. I have provided a chart that will help to illustrate this point (click the chart to enlarge it).

I think it is safe to say that generally, most people refuse to believe the pronouncements of economists concerning when an economy is in the very early stages of either recession or recovery. Consider early recession in the chart. Note that the economy is not very far from its peak in economic activity. So, when economic data are released, the numbers are still very good in a historical context. In fact, unless you focus on what economists refer to as leading economic indicators, the numbers will show an economy that is still climbing the activity "hill" (i.e., to the left of the peak), making it even more difficult to assess what is actually taking place. Perhaps the best example of this is the one measure the general population focuses on most -- the unemployment rate. This is a lagging indicator, meaning its level at present reflects what happened in months past. Remember: a recession is NOT defined as a level of diminished economic activity. As the National Bureau of Economic Research (the "dating" body for economic cycles) points out, it is instead a period of diminishing activity. This highlights the distinction between levels and rates of change that I discussed in the previous post.

Right now, nationally at least, we find ourselves in the early stages of a recovery. Once again, look at the chart above. In the early stages of a recovery, an economy is close to the "bottom" of economic activity. The numbers that are released are therefore not going to be very good, and after a recession period, often discouraging. Of course, if you focus on lagging indicators, you will almost certainly conclude that we are still in a recession.

At this point, I need to reiterate that contrary to popular "wisdom," being in a recovery does not necessarily require a return to "normal" times and historical averages (or above) of economic variables. It might. But generally it takes some time to get back to "typical" levels. The next chart will help to explain this.

As this chart should illustrate, not all recoveries are alike. Each path reflects how rapidly economic activity will be rising in the future. Historically, when there is a very deep national recession like the one we just had, the economy rebounds quickly. This leads to a "V" shaped recovery (the green line). It doesn't take all that long to return to "normal" levels of economic activity. In that situation, a recovery feels like a recovery.

But recovery paths are different since not all recessions are the same. Global recessions occur over longer periods and are generally more damaging than more "typical" recessions. When there is a global recession with major financial problems, as the one we just had, the pace of recovery tends to be slow and it takes a longer time to return to "normal" levels of economic activity (the red line). Consider that at present, individuals are spending less, saving, and paying down debt. Banks have lowered leverage. All of this is very positive in the medium to longer term, but it extracts a cost on the rate of economic growth in the short term. Add to this  the fact that banks aren't lending as much as they might have in previous recoveries, and you get what Mohammed El-Erian of Pimco refers to as "The New Normal" (click here for a video of El-Erian explaining this concept). He and I are somewhat concerned with the possibility of deflation in the near-term as well.

So, where does all of this leave us? What are you to think? Hopefully you are now more aware of  the basics of what is really going on, what an early recovery means, and the possible paths the US economy might take. THE question is which path will be the one our economy follows. Let me be very honest about this: economists, including me, don't really know the answer to this, in spite of all our forecasts and predictions. In this context, let me state one of my favorite sayings: CERTAINTY IS AN ILLUSION. Any forecast, no matter who makes it, is essentially a scenario. It assumes what the areas are that will be the most important over the forecast period, how each of those areas will actually change, and the interactions between and among them. Obviously, there are numerous sources of potential error.

In a period of such uncertainty, where things seldom appear to be what they actually are, many persons are all too willing to step forward with their "solutions." While these might sound good, or appeal to the increasingly subjective notion of "common sense," they too are based on scenarios. So, they might be right. Or, they might be wrong. Let me recommend that you critique any or all of these within the context of one of my favorite sayings: "Complex problems have simple, easy to understand, wrong answers."

Let me finish by acknowledging that at this point you are no doubt wondering where I stand on the future path of economic growth. I will outline this in the coming days (it's time for me to get to class). Before doing that, I need to apply the information in these last two posts to what is occurring in Rhode Island. Stay tuned!