U.S. Economy: Getting the Jobs Recovery to Work Harder

One of the most unfortunate aspects of this generally troubling recovery is the atypically slow pace of employment growth. Until relatively recently, the economy was creating new jobs at a slower pace than even the so-called “jobless recovery” of earlier in this century. It was doing so at barely half the pace of recoveries in the 1980s and 1990s. Explanations dwelt on fears left by the severity of the Great Recession and the burdens of increased regulation as well as complex legislation. But there was little way to verify these explanations and so gain some clarity about how matters might play out going forward. Now new research from the Federal Reserve Bank of St. Louis suggests that these explanations are valid and, in the process, indicates what needs to change for matters to improve.

The Basic Statistics
Though recent, relatively strong employment growth has created something of an optimistic buzz, no one can otherwise deny the fundamentally substandard nature of this jobs recovery. The first two years of the cyclical upturn, 2010 and 2011, for example, saw payroll growth of, on average, only 143,000 jobs a month. That pace improved to 193,000 a month in 2012 and 2013. In the past 12 months, it has jumped again to an average of 274,000 a month. Though this is a gratifying trend in many respects, even the improved pace of job creation falls short of the 309,000 a month averaged for two full years during the cyclical recovery of the early 1980s or the 320,000 a month averaged for a year during the recovery of the early 1990s. It also falls well short of the 342,000 a month averaged for two years in the recovery of the late 1970s. The shortfall looks even worse when considering that the labor force and the economy during those earlier periods was significantly smaller than it is today. The only comparison where recent experience looks respectable is with the recovery early in this century, when jobs growth averaged about 200,000 a month for two and a half years. Yet even that offers little comfort. That earlier recovery should have been more muted, for it followed a very mild recession in which job losses were tiny compared with the devastation of 2008–09, when payrolls declined 700,000–800,000 a month for several months in a row.1

Drilling Down a Little Deeper
Now researchers at the Federal Reserve Bank of St. Louis, Maria E. Canon and Yang Liu, have revealed some of what is happening beneath these aggregates.2 They have disaggregated employment growth according to the sizes of firms doing the hiring, defining small companies as those with 49 or fewer employees, medium-sized firms as those with between 50–499 employees, and large firms as those with 500 or more employees. The researchers reveal that small firms for some time now have accounted for more than half the new jobs created in this economy, with the balance taken up fairly evenly between medium and large firms. This relationship is widely known. Less well known is the authors’ finding that the relative importance of small firms has grown over the last 20-plus years. Going into the Great Recession, small companies, research shows, accounted for fully 56.3% of all job creation. The authors’ further observation that this uptrend has broken since the Great Recession pinpoints the source of this recovery’s disappointing experience. Small firms—the long-standing engine of U.S. job creation—have simply ceased to hire as they once did.

The Whys and Wherefores
If this changed behavior accounts for much of the poor jobs growth exhibited in this recovery, it also points to reasons. As the St. Louis Fed research also documents, small firms are much more sensitive to economic and regulatory changes than are medium-sized or large firms. It stands to reason. Smaller firms are generally less well capitalized than their larger counterparts and have fewer sources of financial support. They have limited resources with which to respond to the compliance demands by government. In hard times or when government presses, the smaller firms cut back on their hiring more dramatically than larger firms and then more than make up the difference when circumstances provide relief. Their comparative failure to do so this time points to a general lack of such relief—a fact that seems to have roots in three influences.

One of these is the shock of the Great Recession of 2008–09. Business declined so far so fast then that many firms, even after engaging in the extensive layoffs already referred to, had trouble meeting payroll. There can be little doubt that the greatest such problems occurred among the smallest firms, with their relative lack of capital and financial recourse. It is little wonder, then, that companies of all sizes, but especially smaller firms, continue to hoard cash and proceed with the greatest caution, especially when it comes to hiring, even now six years into the recovery.

The second of these influences is the impact of the sweeping legislation passed in 2009 and 2010, in particular the Affordable Care Act and the Dodd-Frank financial reform law. Whatever the merits of these laws, there is no denying that they changed the rules radically and so unavoidably increased uncertainties among employers about the ultimate cost of employees as well as the cost and availability of credit. Those uncertainties have lingered, because even now, some five years after they were signed into law, all their provisions and demands are not yet settled. Because smaller firms can least afford to make a mistake, they have responded disproportionately.

The third influence is the increased burden of bookkeeping and compliance imposed by this complex legislation as well as the great increase in regulatory reach. All firms have reacted by going more slowly and more cautiously on any expansions and hiring, smaller firms especially. Unlike their larger counterparts, they can neither justify nor afford the sometimes huge commitment in the time demanded of compliance.

It would seem then that at least three things have to change in order to reestablish small-firm behavior and recapture old rates of jobs creation. Only time will heal the scars of 2008–09. Perhaps bitter memories of those difficult years are beginning to fade, explaining why jobs growth has become more respectable during the last nine to 12 months. It may take still longer for the complex and still vague legislation passed in 2009 and 2010 to become clearer. In this regard, rollbacks, repeals, whatever their virtues or vices, could be counterproductive, for they would only introduce new uncertainties and so make business still more hesitant. The key, then, is some clarity in which businesses, especially small businesses, can have confidence in their calculations of the cost of a new employee as well as of the cost and availability of credit. Clarity also will relieve some of the administrative burdens by allowing firms to put routinized, cheaper, and so less troublesome compliance procedures in place. Only then will managements move forward as aggressively as they once did. A pause in the growth of regulations too would offer similar relief and encouragement for very much the same reasons. Because all this will take time, the improvement in labor markets is likely to unfold only gradually, implying a long wait to see jobs growth comparable to past recoveries.

1 Data from the Department of Labor.
2 All data here and after from Maria E. Canon and Yang Liu, “Firm Size and Employment Dynamics,” February 2015, Federal Reserve Bank of St. Louis.

The opinions in the preceding economic commentary are as of the date of publication, are subject to change based on subsequent developments, and may not reflect the views of the firm as a whole. This material is not intended to be relied upon as a forecast, research, or investment advice regarding a particular investment or the markets in general. Nor is it intended to predict or depict performance of any investment. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information. Consult a financial advisor on the strategy best for you.

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