An employment recession

may already be with us

We learned Friday that the US economy shed 4,000 jobs in August, the first decline in payrolls since 2003. The bad news spread retroactively to previous months, as the numbers for June and July were revised down.

The disappointing jobs report came on the heels of a series of worrying signs that a credit crunch may be pushing the US economy into recession. On the other hand, indicators such as retail sales have been rosier. Has the economy entered recession? And how could we tell if it did?

A quick look at the jobs numbers suggests that the negative report is quite ominous. In the 692 months since January 1950, the employment change has been positive in 542 months and negative in only 150 months.

Employment changes have tended to be positive, of course, because the economy has generally been expanding. Since job changes are so coincident with the rest of the cycle, negative months are concentrated in recessions. Indeed, fully 77 percent of the jobs reports during recessions showed negative job growth. Outside of recessions, jobs were destroyed on net only 12 percent of the time.

So, seeing a negative month outside of a recession is pretty unlikely. But it does happen. When is bad news bad enough that alarm bells should go off?

The best way to think about the problem is to use a recession model that was pioneered by the brilliant economist James Hamilton of the University of California at San Diego. In a path-breaking paper in the distinguished journal Econometrica published in 1989, Hamilton created a model of the recession that is still the gold standard for economists.

Revolutionary impact

The Hamilton model is intuitively quite simple, but in practice it has had a revolutionary impact on the way economists view recessions.

The model works like this: Assume that God sits in a room with two urns (colored red and black) before him. Each urn is filled with little balls that have numbers written on them. In the black urn, the average number on the balls is about two-and-a-half, but the numbers vary widely. In the red urn, the average number on the balls is about negative one-half, though the numbers also vary.

Each quarter, God pulls a number out of one of the urns, and that number becomes US gross domestic product (GDP) growth for that three-month period. In addition, he tends to take a ball from the urn he drew from in the previous period.

In this setting, the problem for the econometrician is relatively simple. He must identify at any given time whether God is drawing from the red or the black urn. Say we observe a negative GDP number. It might be that the number is from the red urn, and that we have entered a recession. It may also be that the draw was from the black urn, and was just negative because of noise.

Next report crucial

How can you tell if the number was drawn from the red “recession urn”? Hamilton’s model tells us that the key is what happens next. If God made a bad draw from the good urn, then the next draw will be back around two- and-a-half. If he made a bad draw from the other urn, then the next draw will be negative as well. As the sequence of negative numbers builds up, our feeling that God is drawing from the bad urn grows.

So a crucial thing to watch will be the next report. If it, too, is negative, then we will have had two such employment reports in a row. Since 1960, we have never had two consecutive negative employment months, except for during or shortly after a recession. One could reasonably conclude that God has turned to the red urn. There will be lots of public opinion about a recession between now and then, yet we won’t know until we see the number.

Signs of hope

Will the next reading be negative? There are a couple of reasons for hope.

First, a key element driving employment south this summer was a sharp decline in government employment. Employment actually increased in private industry. It may be that the reduction in government payrolls is a statistical anomaly that will reverse itself shortly.

The second piece of good news was highlighted last week by Michael Darda, chief economist at MKM Partners, a Greenwich, Connecticut, trading and research firm. Darda noted that unemployment claims haven’t shown deterioration to this point, something they should have done if the employment situation were as bad as the latest report suggests.

That gives Darda, and the rest of us, hope that the bad news won’t get worse.

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Dear Pal,

First, let’s put things in the proper context: a soldier blew the whistle on a rogue intelligence-gathering operation called Project Lighthouse; the majority of your colleagues thought the story, if true, could have grave national-security implications, so they initiated an investigation.

The business-process outsourcing (BPO) sector has grown by spectacular levels, providing employment to more than 200,000 BPO professionals. Projected to grow at an average of 38 percent until 2010, it will contribute more than $12 billion in revenue.

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It seems that my column on Wednesday (“Geny Lopez and his values”) had a mixed effect on the sensibilities of some of the younger members of the Lopez family—Gina and Rina Lopez (both daughters of the “Kapitan”) and Piki Lopez, son of Oscar (Geny’s and Manolo Lopez’s brother).

My apologies for being blunt, but I believe the government should simply scrap the unexecuted contract for the proposed national broadband network.

We learned Friday that the US economy shed 4,000 jobs in August, the first decline in payrolls since 2003. The bad news spread retroactively to previous months, as the numbers for June and July were revised down.