Smith Faculty Opinion Article January 6, 2006

Economy Adds 108,000 Jobs, Wages Lag Inflation in 2005
By Dr. Peter Morici, Professor of International Business

Today, the Labor Department reported the economy added 108,000 payroll jobs in December. The consensus forecast was 207,000, and my forecast, published by Reuters was 180,000.

Unemployment fell to 4.9 percent, mainly because fewer adults chose to participate in the labor force.

In the fourth quarter, 438,000 jobs were added, and this is consistent with GDP growth in the range of 3.0 to 3.5 percent

Economic growth appears to be moderating from the red hot numbers posted in the third quarter, and if the Fed does not push interest rates too much higher, the economy will grow at a 3.5 percent pace the first half of 2006.

Wage increases were moderate, despite fears that labor markets are too tight.

Wages were up 0.3 percent. Wages are advancing less rapidly that productivity, indicating that a tightening labor market poses little threat of igniting inflation.

In light of recent productivity gains, this moderate wage growth should dispel any notions the Fed may hold labor markets and spiraling wages could reignite inflation.

In 2005 wages grew 3.1 percent, while inflation exceeded 3.5 percent.

It was a year of big bonuses and hefty raises for highly skilled professionals and executives but slim pickings for the ordinary working Joe.

Such tepid wage growth is particularly disappointing given the strong productivity advances posted by the private business sector over the last year.

Moderate wage growth and strong productivity growth should soon convince the Fed to end its cycle of interest rate increases soon. The Fed will increase the federal funds rate to 4.5 percent on January 31 but increases beyond 4.5 percent are less likely.

Manufacturing employment increased 18,000; however, employment in that sector has been unchanged since June and down 51,000 since last December.

Inexpensive imports, especially from China, are holding down employment in manufacturing and some service activities, clamping down on wages even as the economy grows.

The continuing competitive woes of General Motors and Ford compound the damage inflicted by the trade deficit.

Together, the trade deficit and troubles of U.S. automakers cast a long shadow over the job market. Overall, the manufacturing sector has shed three million jobs since 2000, and by this point in the recovery, two million of those jobs should have been recovered.

Paradoxically, an overvalued dollar plays a key role in slow wage growth and the inverted yield curve, which has recently captured the headlines.

To keep their currencies cheap against the dollar, China and other foreign governments buy billions of dollars of U.S. government securities. Foreign government purchases of U.S. securities drive down long-term interest rates, and these make possible inexpensive mortgages and home equity loans. However, those foreign government purchases of U.S. securities also subsidize U.S. imports and stifle the growth of jobs offering good pay and benefits.

Peter Morici is an economist and professor at the Robert H. Smith School of Business, the University of Maryland, College Park, MD. E-mail: pmorici@rhsmith.umd.edu.