The Bureau of Labor Statistics’s (BLS) February employment report showed solid labor market growth. Employers added 236,000 net new jobs, and the unemployment rate dropped to 7.7 percent from 7.9 percent. However, the labor market is weaker than the headline numbers suggest.
It remains unclear whether the labor market is improving. One factor that Congress should not worry about, however, is sequestration. Economic research shows that reducing spending growth does little economic harm; the same does not apply to tax increases. Congress should resist any proposals to replace sequestration with higher taxes.
February Employment Report
The headline numbers in the February employment report showed solid growth in the labor market. The payroll survey showed net employment expanding by 236,000 jobs. The professional and business services (+73,000), construction (+48,000), health care (+32,000), and retail trade (+24,000) sectors all increased employment significantly. Employment edged down slightly in state and local government (–10,000).
The establishment survey also found average weekly hours rising by 0.1 hours and average hourly earnings rising by 4 cents. Sustained increases in hours and wages often signal rising labor demand. The household survey reported the unemployment rate dropping 0.2 percentage points to 7.7 percent—its lowest level since the Great Recession began.
Other indicators also point to an improving labor market. The four-week average of new unemployment insurance claims has fallen below 350,000, the lowest rate since early 2008. Employers are laying off fewer workers than at any point in the past five years.
Less Than Meets the Eye
Encouraging as these signs are, there is less to the employment report than meets the eye. Unemployment fell because almost 300,000 workers left the labor force. The population grew as much as total employment did. As a result, the employment–population ratio remained flat at 58.6 percent. Labor force participation declined 0.1 percentage points to 63.5 percent, tied for the lowest reading in over 30 years. Unemployment improved only because hundreds of thousands of potential workers stopped looking for jobs. Revisions also subtracted a net 15,000 jobs from the December and January employment reports.
In part this reflects the aging of the baby boomers. The labor force participation rate among 25- to 54-year-olds remained flat (81.2 percent), but the overall rate declined because of the increasing number of Americans approaching retirement age. The aging of the population will continue to put stress on the economy in coming decades.
Another concern is the pattern of “spring boom, summer swoon” in BLS reports since 2010. In each of the past four years, the BLS employment report has shown strong growth in the late winter and early spring, followed by anemic growth in the summer. The winter and spring reports have led to hope for summer growth that then fizzles.
This pattern may be a result of the economic collapse of late 2008 and early 2009 interfering with the BLS seasonal adjustment process. The BLS’s algorithms may “expect” large job losses in the winter and spring that do not materialize, making their seasonally adjusted job reports appear artificially strong. This month’s good numbers could represent a similar statistical mirage, similar to the growth in early 2010 that led the Administration to predict the “recovery summer” that never arrived.
Overblown Sequestration Fears
Looking ahead, policymakers need not fear slower job growth due to the recent sequestration, which will force the federal government to cut $85 billion in budget authority this year. That will slow the growth of 2013 spending by only about $42 billion. The federal government will still spend more in 2013 than in 2012. The cuts to “government consumption”— the component of government spending that includes payrolls and purchases—will be largest in the military but will barely touch entitlement spending. Military procurement has already fallen due to previous cuts and in anticipation of sequestration, but that has not noticeably impacted job gains in the rest of the economy.
The federal cuts from sequestration, which will be enacted gradually over the next two years, should not negatively impact private-sector job growth. Economists Alberto Alesina, Carlo Favero, and Francesco Giavazzi have found that spending-based corrections are followed by little decline in gross domestic product (GDP), with recovery following within a year. (When government consumption is cut, GDP declines mechanically: Government consumption is one component of GDP.) By contrast, tax-based corrections lead to extended recessions enduring at least three years.
International experience suggests that if the federal government attempted to balance its budget using large tax increases, an extended recession would follow. If recent recessions are any indication, a new recession would lead to large automatic and discretionary increases in government spending, which would use up the new tax revenue without dealing with the deficit. That was the experience of many countries analyzed by Alesina in a paper with Silvia Ardagna: Despite higher taxes, debt-to-GDP ratios did not shrink.
A robust cut in government spending, on the other hand, which might decrease GDP in the short term even if it does no harm to the economy, would quickly give way to growth. Alesina, Favero, and Giavazzi’s results imply that the void left by decreased government spending is filled within a year by increased investment and private consumption, and the economy continues growing.
The last quarter of 2012 is a good example of what happens when government consumption falls. The government consumption fall is immediately reflected in GDP, leading to bad headlines. But the private economy was unscathed, and the last several jobs reports have shown that the slight decline in government consumption did not break the pattern of moderate job growth.
Real or Illusion?
The economy continues to gradually improve. The February employment report shows stronger-than-average growth, although it is too soon to determine whether that growth is real or a statistical illusion. The drop in unemployment, in particular, occurred largely because people left the labor market.
Policymakers should not worry that sequestration will disrupt growth. Economic research shows that spending-based deficit-reduction plans, unlike tax-based plans, do not damage the economy. Sequestration is an imperfect first step toward the spending reductions necessary to balance the budget. Congress should reject any proposal to replace part of sequestration with tax increases.
—James Sherk is Senior Policy Analyst in Labor Economics and Salim Furth, PhD, is Senior Policy Analyst in Macroeconomics in the Center for Data Analysis at The Heritage Foundation.