Is the Recent Decline in RI's Labor Force an Anomaly?

Yesterday we received the April labor market data for Rhode Island. While many celebrated the fact that our state's jobless rate fell below 9%, I raised the question, as I have on numerous occasions over the years, about whether or not this is truly cause for celebration. Clearly, a lower jobless rate is preferred to a higher one. However, is important to assess not only the level of the unemployment rate but the reasons that underlie how (and why) it is changing.

My guess is that many people here believe that the April decline in our labor force that accompanied our jobless rate improvement really isn't very important, and that somehow this was a one time or rare event. Instead of my stating what I believe is the only reasonable conclusion here, I will let you judge for yourself. Below is a chart (click to enlarge) that shows Rhode Island's labor force and unemployment rate dating all the way back to 2009. Included in this chart is a vertical line denoting when the current recovery began (in February 2009).

I believe the graph illustrates rather conclusively that the combination of declines in both the unemployment rate and labor force is not the exception, but instead has been the rule over this entire period with few exceptions. Let me state that even prior to 2009, there were more instances that I can remember where we saw this combination of declines in both our unemployment rate and labor force.

In fact, when I designed my Current Conditions Index (CCI), I explicitly took this relationship into account, which I would not have done for any other state. Specifically, I included as two separate indicators the labor force and the unemployment rate. The significance of including them as a pair arises from months like April: an improving unemployment rate is a +1 for the monthly CCI value, while the decline in the labor force is a -1. The result is that these two changes cancel, leaving the  monthly CCI value unchanged. Therefore, a decline in Rhode Island's jobless rate by itself does not necessarily improve the Current Conditions Index value for a given month.

Let me conclude by noting a unique fact for Rhode Island. Rhode Island is the only state that has been consistently losing population since July of 2004. In general, a smaller population adversely impacts the size of a state's labor force. In the coming months, this will make it more difficult for Rhode Island to reverse the well-established downtrend in its labor force.

Recovery Rhode Island Style

Rhode Island never seems to do things like other states do. Sometimes that can be a good thing. But when it comes to economic performance, it has proven to be a nightmare: Our nightmare -- an extremely tepid recovery that might now be over.

In my first post on this Blog, I provided a series of charts comparing Rhode Island to the US, New England, Massachusetts, and Connecticut. I have (sadly) updated the most important of them, payroll employment, with the most recent data. The chart below shows this (caution: if you have just eaten, you should probably wait about an hour before viewing this chart. For those who haven't just eaten, click to enlarge):

I would hope that most people are aware of the following stylized facts that should be readily apparent from the chart:

1. Payroll employment in Rhode Island peaked in December of 2006, well before the peaks in the US, New England, Massachusetts, or Connecticut;
2. Rhode Island's payroll employment fell by a greater percentage than any of the other entities in the chart, by 8% from its peak;
3. At its best during this recovery Rhode Island's payroll employment moved back to just slightly above 93 percent of its prior peak;
4. All of the other entities in the chart have seen rising employment for some time now, moving ever closer to their prior peaks while Rhode Island has regressed -- its payroll employment is declining, falling back to just above 92 percent of its peak level.
5. If you want to see what is happening to the unemployment rate in all of these entities, flip this chart upside down. This explains why Rhode Island has such a stubbornly high jobless rate -- we're not creating jobs!

An observation: during recoveries, payroll employment is supposed to continually rise. But this is Rhode Island. We don't do things here the same as everywhere else. If you look at my prior few posts, payroll employment in Rhode Island has now declined on a year-over-year basis for the past seven months. That by itself might be a sufficient basis to believe Rhode Island's recovery has ended and we have entered into the early stages of a double-dip recession. At present, I am not quite ready to make that call, but I think it is safe to say that if we are still in a recovery, we're hanging on by our proverbial finger nails.

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.

Retail Sales in Rhode Island Since the Last Recession

One of the most critical elements that determines Rhode Island's economic momentum is retail sales. Retail sales drives a great deal of economic activity here while itself being determined by how well the overall economy does. Remember, too, that sales tax revenue is an important source of Rhode Island's overall tax revenue.

Retail sales have done better since Rhode Island emerged from its last recession in February of 2010. But, like so many other economic measures, its behavior during this recovery has been choppy at best, reflective of the fact that our state's rate of growth has recently begun to slow.

The best way to analyze retail sales is to take inflation into account. Doing this we obtain real (i.e., inflation-adjusted) retail sales. I have calculated these so that the most recent month of data, April 2011, is the base period (the basis for comparison). The chart below shows real retail sales for Rhode Island since 2007 (click to enlarge).

The most striking feature of the performance of retail sales since 2007 is how far they fell. A quick look at the graph also shows rather disturbing trends not only in their rate of decline but the duration over which their decline occurred. All of this is a testament to how severe the last recession was. It wasn't given the name "The Great Recession" for nothing! From this chart, it should also be fairly easy to grasp one of the reasons why tax revenue here declined during the last recession and has only recovered a bit during this recovery.

During the last recession, real retail sales moved into a downtrend in June of 2007 that lasted for over three years. The "breakout" from this prolonged downtrend, which coincided exactly with the beginning of Rhode Island's current recovery, occurred in February of 2010. 

In more "normal" times (I have forgotten what those actually are by this point), we would have seen a fairly rapid rebound from such a precipitous decline in retail sales. But in those times "leverage" was rampant as credit, whether credit cards or home equity lines of credit, were used without a second thought, banks were very generous in their lending, mediocre credit scores weren't much of an impediment, and collateral was something that persons had to have back in the dark ages. But that was then. The chart above shows now -- not a very substantial recovery in real retail sales. After an initial jump, real retail sales began to fluctuate, largely sideways but trending slightly downwards, meaning that the value of retail sales has barely kept up with inflation. The same has been true for manufacturing wages here (see previous blog post on this). The recent slight downtrend also illustrates that the pace of economic activity in Rhode Island has been slowing of late.

Will real retail sales here break out from the most recent downtrend? Several factors could allow this to occur, namely low interest rates and ongoing national and state recoveries. However, the low and declining interest rates themselves reflect a slowing in the pace of national economic activity. Add budget problems in RI (sorry to be redundant) and for the US, and pension woes that must be addressed, and it becomes apparent that it is largely the underlying cyclical momentum of the US and Rhode Island economies that will largely determine whether a breakout occurs. Should these factors fail, our state faces the prospect of a breakdown below the recent trend, potentially eliminating some or much of the relatively small recovery gains we have experienced over the last year. Should that occur, revenue "surprises" will quickly become disappointments. Let's keep our fingers crossed that this is not what occurs. We already have enough on our state's plate as it is!

Scrutinizing Economic Forecasts: RI Employment Growth

In the most recent Revenue Estimating Conference, a rather interesting projection of future payroll employment for Rhode Island was made. According to this forecast, not only would Rhode Island's payroll employment rise in the next four years, this projection saw it actually returning to its pre-recession peak by the end of that period. To say that this forecast is optimistic is truly an understatement. Let me explain why this is the case.

First, and foremost, we need to consider how far we are from our pre-recession employment peak. Second, we must take historical growth rates into account to get an idea of what is possible or likely. Finally, as with any forecast, it is necessary to incorporate current and likely future conditions in arriving at a final forecast.

As for the first point, Rhode Island is now slightly more than a year into its current recovery. That recovery is from "The Great Recession." It takes a truly severe recession to merit a name, which is what we had nationally and in Rhode Island. As of March 2011, here's the data for payroll employment in Rhode Island needed to determine this (all data are seasonally adjusted, in thousands):

Pre-Recession Peak:            496.5

March 2011 Employment:     460.2

             Required Increase:                 36.3 (= 7.9%)

So, this forecast requires a four-year employment increase of 7.9 percent. Because growth compounds, that does not mean annual growth is just this figure divided by four. Taking compounding into account, assuming a constant rate of growth over this period, gives a required annual rate of growth of 1.92 percent.

Moving to the second point, what is the historical behavior of growth in Rhode Island? A graph will allow me to convey this information fairly effectively. Below is a chart of annual rates of change in payroll employment for Rhode Island since the end of World War II, starting in 1947 (click to enlarge). I have separated the period when Rhode Island was a manufacturing-based economy (through 1987) and its post-manufacturing period (since 1987).

How likely has it been for Rhode Island to experience job growth just below 2 percent for four consecutive years? In the post-manufacturing era, this occurred only once -- during the tech boom of the late 1990s. Look closely at growth rates for all the other years, especially since 2000. Not very impressive, to say the least. So, this could happen, but it requires that we replicate an extraordinary set of circumstances during a tech boom, the likes of which we haven't seen since. Note also, how Rhode Island's job growth failed to sprung back very sharply from the severe job losses in 1990 and 1991. So much for V-shaped recoveries here!

This brings me to the final point, taking current circumstances into account. At the risk of being redundant, Rhode Island has a string of large budget deficits ahead. Add to this unfunded pension liabilities, financial crises in cities, most notably Providence, which may well run out of money by early fall, a slowing national economy, and our state's labor force which has major  skill deficiencies, and it is apparent that there is a large and growing number of factors that will continue to mitigate the pace of cyclical momentum here. This has been confirmed by the recent performance of my Current Conditions Index, which shows that Rhode Island's economic growth has slowed since the third quarter of 2010. There are several positives as well. Rhode Island is in a recovery that, as of the March data, has extended thirteen months since its beginning in February of 2010. Also, the recent labor market data revisions show that our state's employment picture is better than we were led to believe based on the prior data. Lastly, Rhode Island did institute some structural changes to the cost of doing business here, notably lowering income tax rates. We therefore have some margin for error.

In light of all this information, I can't conceive of any realistic scenario under which this forecast ultimately proves to be accurate. For someone who has been analyzing Rhode Island's economy for longer than I care to say, I generally consider a one percent growth rate for employment here as a "norm," unless other factors intervene. And, if the problems in Providence are anywhere near as severe as I believe them to be, their resolution, either with or without the help of the state, will inevitably slow Rhode Island's rate of growth for several years.

MY FORECAST: IT WILL TAKE SEVEN TO EIGHT YEARS FOR RHODE ISLAND'S PAYROLL EMPLOYMENT TO RETURN TO ITS PRE-RECESSION PEAK.

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!