The surge in global unemployment has proven to be an enduring scar of the financial crisis and one that has still not fully healed. The implications of fundamental shifts in the structure of the labour market are substantial and wide-ranging, and present major challenges to policymaking.
The US labour market continues to improve, setting the stage for sustained Federal Reserve QE tapering. We continue to see US Treasury yields heading higher in the months ahead, particularly as the risks to our employment outlook are to the upside.
Employment trends across emerging markets are mixed, with economic slowdowns in several countries resulting in loosening labour markets. In general, we do not see labour market tightness as a problem in most emerging markets.
The surge in global unemployment has proven to be an enduring scar of the financial crisis and one that has still not fully healed. Unlike the sweeping inferences we can sometimes make about groups of economies (such as core eurozone outperformance versus periphery stagnation), the distribution and dynamics underpinning global unemployment do not conform to neatly defined comparable trends. In the US, unemployment has steadily fallen but the participation rate has collapsed. In the UK, the recession has been one of the worst on record when measured against the yardstick of GDP, but has been the shortest in history when measured by unemployment given rapid job creation and a stable (and slightly increasing) participation rate. Core eurozone unemployment is not universally benign, with high French joblessness and a steady rise in Dutch unemployment countering the historically low and still falling unemployment in Germany. In the periphery joblessness is unambiguously bad, but there is still a world of difference between an unemployment rate of 11.9% in Ireland and 27.5% in Greece (in addition to an under 25s rate of 59%).
| Digging Beneath Headline Unemployment |
|US & UK Labour Force Participation Rates, %|
The two defining elements that are common to developed states are that labour markets have become more polarised and trends more structural than cyclical. In the case of the former, a particularly pernicious dynamic has been the 'hollowing out' of the labour market as middle class jobs have disappeared since the financial crisis, while demand has been relatively more robust for very high and very low skilled workers. This has happened before. Blue collar manufacturing jobs, particularly in the US, used to be both abundant and well paid, providing a means for low to medium skilled workers to significantly raise living standards and transition into the middle classes. The advent of the 1990s computing revolution, coupled with the enormous increase in the global labour force as previously communist states transitioned towards market based economies, underpinned a structural decline in demand for manual workers in developed states. While some of these workers became structurally unemployed or fell out of the labour market altogether, others migrated to the service sector or upgraded skills to satisfy demand for more technical jobs.
| Diverging Outlooks |
|Global - Unemployment Rates, %|
Shifting patterns of labour demand now threaten many of the jobs that were created in the 1990s and 2000s, which had filled the gap left by traditional manufacturing. Indeed the 2008-2009 financial crisis has exposed a sharp change in labour market fundamentals, which was previously obscured by a debt-fuelled consumption binge (creating many inefficient service sector jobs) and a swelling pool of graduate workers (fuelling the illusion that the workforce had become more highly skilled). The long-term deleveraging process has killed off a large chunk of service sector jobs previously occupied by the middle classes (the 'hollowing out' dynamic), while many university graduates lack the skills necessary to compete in a job market increasingly demanding technical skills for the finance, technology, science and engineering industries. Although there are signs that new university entrants are responding to the change in labour market demand as enrolments in scientific and mathematical subjects have increased in some cases, many of the service sector jobs which paid middle class wages to non-graduates and non-technical graduates are not coming back.
The second element which unites labour market dynamics across developed states is that trends have become increasingly structural rather than cyclical. It can be tempting to some to argue that the post-crisis rise in unemployment is cyclical and will normalise alongside economic recovery. However, in addition to the fundamental shift in the supply and demand for labour mentioned above, every year which passes with persisting high unemployment increases the likelihood that joblessness becomes structural. Through hysteresis effects, human capital depreciates as skills deteriorate or even become obsolete, making it more difficult for the unemployed to find work. Bar one or two anomalies this is broadly the case across the developed world, even in the US and UK where headline unemployment has been falling.
A Headache For Policymakers
The implications of these fundamental shifts are substantial and wide-ranging, so we will just briefly outline two points of consideration. First, recent labour market developments probably provide the best insight into structural changes across economies. Indeed, inferences about quarterly GDP growth rates or how much one economy exports relative to another miss the fundamental economic restructuring taking place, which is most visible in the changing composition of the labour market. For example, a dwindling middle class (a trend which materialised years before the financial crisis) knocks out one of the most powerful engines of economic growth and will have significant implications for asset class strategies both in terms of aggregate corporate earnings, and sector specific exposures such as consumer discretionaries.
Second, labour market dynamics pose a major challenge for policymakers. For national governments there is considerable pressure to invigorate job creation and kick start economic growth. While it may be relatively straightforward to ramp up employment in the low skill sectors (the downside obviously being a potential downshift in aggregate productivity), clawing back the aforementioned lost middle class jobs would be extremely difficult in light of ongoing technological change, as would be driving up high-skilled employment which requires long-term investment in education and the associated infrastructure. In short, there will be no near-term fundamental improvement in labour markets beyond a potential reduction in headline unemployment, which is itself not an unambiguously positive development. The labour market has also become a key instrument in the design of fiscal and monetary policies with assumptions about equilibrium unemployment having a direct bearing on estimates of the structural fiscal deficit (and by implication the amount of fiscal austerity required to close budget deficits), and determining how much spare capacity is in the economy, which has become a deciding factor for when monetary policy should be tightened. In both cases policymakers have been wrong footed by the labour market, either in estimating the equilibrium unemployment rate, or predicting the path of unemployment (French President Francois Hollande expected unemployment to go down when it actually went up, while the Bank of England completely underestimated the speed at which unemployment would fall).
US Unemployment - Getting Better: Countering faltering US economic data at the turn of the year, February's non-farm payrolls grew by 175,000, the strongest growth in three months. The February print was above consensus estimates of 149,000, suggesting that the weakness seen in December and January figures was not the beginning of a prolonged trend of weaker job creation - indeed, the January figure was revised up from 113,000 to 129,000.
| Jobs Rebound After Two Weak Months |
|US - Change In Nonfarm Payrolls, '000 & Unemployment Rate, %|
Looking at the labour market from a broader perspective, it is increasingly clear that while still relatively weak, the US economy is hitting 'escape velocity'. The February print is closer to the robust job creation numbers posted for much of 2013, broadly ranging between 150,000 and 200,000 new jobs a month, which helped drive a tightening in the labour market that we forecast will continue in the months ahead. While the unemployment rate ticked up slightly to 6.7% in February from 6.6% in January, we maintain our forecast for a 6.2% unemployment rate by end-2014. With the labour market tightening, wage growth should continue to improve, as the chart below indicates. After 23 consecutive months of negative year-on-year real wage growth in 2011 and 2012, higher nominal wages and relatively low inflation has pushed real wages higher for the past 13 consecutive months, with nominal wages increasing by more than 2.0% y-o-y since June 2013. This has key implications for US monetary policy, as the unemployment rate inches closer to an acceptable level for the Fed, and wage hikes finally begin to put a floor on inflation. We continue to see US Treasury yields heading higher in the months ahead, particularly as the risks to our employment outlook are to the upside.
| Tighter Labour Market Should Boost Wages |
|US - Unemployment Rate (Lagged) And Wage Growth|
Latin America - Some Erosion of Labour Market Gains Ahead: We forecast that the average unemployment rate in several major Latin American economies will rise in 2014, as economic activity moderates or remains relatively weak throughout much of the region. We expect that slower real GDP growth will unwind some of the labour market gains experienced by Latin American economies in the last several years, when strong economic expansion, and in some cases reforms, helped to reduce informality and underemployment. Indeed, we foresee a moderate uptick in the average unemployment rate in Peru, Chile and Brazil this year, consistent with our view that economic headwinds in the form of weaker Chinese demand for industrial metals and lower average metals prices will continue to temper growth in these economies. While we foresee no change in Argentina's average unemployment rate this year at 7.1%, we expect that unemployment will rise to 7.8% by end-2014 in light of significant domestic economic headwinds.
| Colombia And Mexico Buck The Trend |
|Latin America - Selected Economies Average Unemployment Rates, %|
We foresee a different story in Mexico and Colombia in 2014. We believe that a pick-up in Mexican real GDP growth to 3.3% this year, from 1.1% in 2013, due in large part to stronger activity in the manufacturing and construction sectors, will contribute to a moderate decline in the average jobless rate to 4.2% in 2014, from 4.9% last year. Moreover, favourable demographics and a period of stronger economic growth will see Mexico's average unemployment rate decline to 3.5% by 2016. We also forecast a drop in Colombia's unemployment rate in the coming quarters, with the jobless rate set to average 8.5% in 2014, from 9.6% in 2013. Indeed, we expect that growing opportunities in the commercial, hotels, and professional services sectors, which account for nearly half of total employment, will underpin a continued reduction in the unemployment rate this year.
Emerging Europe - Limited Labour Market Tightness Among CE4: Although structural changes since 2008/09 make it difficult to gauge the health of emerging European labour markets, we believe unemployment is close to its natural rate in the Baltic economies, whereas Central Europe will see unemployment fall further over the next few quarters. All three Baltic states have seen relatively strong wage inflation through 2013 (particularly Estonia), and with capacity utilisation rates converging to pre-crisis highs, job creation is accelerating. We believe this trend has been exacerbated by massive emigration, which has accelerated the skills mismatch and tightening of domestic labour markets, thereby intensifying wage growth pressures in growth sectors.
| Central Europe Has More Slack |
|Q414 Capacity Utilisation Rate Minus Pre-Crisis Average, pp|
Central Europe, on the other hand, appears to have some way to go before wage pressures really start to build. Of the CE4 economies only Poland currently has capacity utilisation above its pre-crisis average, whereas the Czech Republic and Slovakia remain a long way off. Even Poland has a notable absence of demand-pull inflationary pressures, implying that the export-led recovery in Central Europe can continue through H114 without leading to significant tightness in the regional labour market.
Asia - Regional Employment To Deteriorate: Developed Asia unemployment trends are likely to deteriorate in over the coming quarters as Chinese demand slows. Indeed, this trend is already in play in Australia, with the unemployment rate on an uptrend since mid 2011, and we expect the unemployment rate to hit 6.5% by the end of 2014 from 5.8% in 2013. Australian GDP growth continues to weaken - we forecast it will slow to 2.0% in 2014 from 2.4% in 2013 - and this, combined with increasingly expensive labour, will weigh on employment prospects. The rest of developed Asia is still seeing unemployment trending lower, but we highlight that the trend could change, particularly for Japan.
| Developed Asia Unemployment To Worsen? |
|Asia - Unemployment (%) & Japanese Participation Rate (%) RHS|
We believe that Abenomics-fuelled inflation in Japan will lead to a decline in real incomes, which could force people back into the labour force. Indeed, Japanese on fixed incomes will likely see their purchasing power eroded by rising prices, and with a significant share of wealth stored in JGBs, any uptick in inflation could see yields push higher and the value of JGBs fall. As such we would not be surprised to see an increase in both the participation and unemployment rate over the coming years as people return to the labour market to supplement their incomes.
Sub-Saharan Africa - Unemployment Poses Key Long-Term Threat: African economies are booming, but unemployment remains high and BMI believes that Zambian finance minister Alexander Chikwanda is right to describe the risk to social stability posed by rising youth unemployment as 'a ticking time bomb'. The dominance of the informal sector makes calculating exact unemployment figures difficult - even in relatively developed Kenya few than one in six jobs are in the formal sector. We estimate, however, that unemployment is above 20% in many countries including key markets such as South Africa and Nigeria.
| Formal Sector Producing Few New Jobs |
|Kenya - Formal Employment, '000s (LHS) And Share Of Working-Age Population, % (RHS)|
Population expansion is one key cause of unemployment in many African states; high birth rates slash per-capita economic growth to a crawl in countries like Mali and Kenya. The continent already has the world's youngest and fastest growing population, and even fast-growing economies will struggle to absorb the additional 11 million youths that join the African labour market each year.
The employment impact of high economic growth in Africa has also been reduced by a dependence on capital-intensive extractive industries - mines and oil rigs will never create as many jobs as labour-intensive factories. Some African economists hope that low wages will draw in manufacturing investment as production costs in Asia rise, but BMI believes that poor infrastructure and high non-wage costs make this unlikely.
Africa suffers problems of labour supply as well as demand; the African Development Bank estimates that 133 million young people on the continent are functionally illiterate. Where education does exist it is often poorly targeted; 70% of university students study humanities subjects and few states produce many of the technicians, geologists, and engineers that are in high demand. International firms' widespread use of migrant labour has become contentious in many countries, and we expect labour tensions to increase.
MENA - Effectiveness Of Labour Market Reforms Remains In Doubt: Governments across the six economies of the Gulf Cooperation Council (GCC) have scaled up their efforts to boost employment opportunities for nationals since the start of 2013. Regional workforce nationalisation schemes aim to wean citizens away from public sector positions and attract them to the expatriate-dominated private sector, through enticements and the imposition of limits on the supply of foreign labour. Although we expect ever-more stringent policy measures to be implemented across the region over the coming years, tangible improvements in private sector enrolment amongst nationals will come only slowly, in our view. Such policies will most likely fail to address the root causes of the GCC's structural unemployment problem, while raising the costs for private sector companies and creating short-term disruptions to economic activity.
| Labour Regulations On Companies' Minds |
|GCC - % of Respondents Listing Selected Factors As Most Problematic For Doing Business*|
The issue of unemployment in the GCC is complex, and due to a combination of factors including significant wage discrepancies between the public and private sector, skills mismatches (the consequence of historical underinvestment in education), and low female participation rates. Labour market reforms will not entice nationals to move towards labour-intensive sectors such as construction and household services, where employees typically work for long hours in difficult conditions for a fraction of the wages offered by the public sector. The most recent Global Competitiveness Report by the World Economic Forum clearly highlights labour regulations and the weakness of the national workforce as the key issues facing investors doing business in the GCC (see chart).
Given the importance of the GCC's outward remittances for many Arab and Asian economies, the implementation of workforce nationalisation schemes will have substantial regional implications. Remittances from nationals working abroad act as a crucial source of income and hard currency for net oil-importers, and help to alleviate high domestic unemployment. The return of these workers will therefore exacerbate political and balance of payments pressures in countries ranging from Bangladesh to Yemen and Pakistan.