Glimmers of hope

Illustration by S. Kambayashi

WHEN Barack Obama visited Elkhart, Indiana, in early February, a few weeks after his inauguration, it was a sombre affair. In the previous 12 months the area's unemployment rate had more than tripled to 18.3%. The president pleaded for the passage of a massive fiscal stimulus, insisting that “doing nothing is not an option.” By the time he returned to Elkhart on August 5th he was quite a bit sunnier. Local factories are “coming back to life”, he proclaimed. Two days later he declared: “We're starting to see a kind of resurgence of optimism.”

Mr Obama's good spirits are well grounded: America's recession appears to be coming to an end. On August 7th the government reported that the unemployment rate fell to 9.4% in July from 9.5% in June, the first drop since April 2008. Non-farm employment fell by 247,000, or 0.2%, weak in absolute terms but the least in 11 months, giving clear evidence of dissipating downward momentum.

On July 31st the government reported that real gross domestic product (GDP) contracted in the second quarter, but at only a 1% annual rate. Much of that decline reflected business's determination to keep factories and workers idle and fill new orders out of existing inventory. Now, stocks are so depleted that production will soon have to restart. GDP will probably rise in the current quarter by as much as 3%. In July, manufacturers reported that new orders were growing briskly, the best in over two years, and car sales jumped by 15% to an annualised 11.2m.

Mr Obama and his aides have wasted no time in crediting the $787 billion fiscal stimulus for spurring this recovery. On August 6th Christina Romer, his chief economist, unveiled estimates that the plan had boosted second quarter payrolls by 485,000 and growth by 2.3 percentage points (against what they otherwise would have been). While nothing to sneeze at, that contribution is probably far less important than the massive injection of private and public capital, loans and loan guarantees into the financial system and bank stress tests which probably stopped the recession from becoming a depression.

Despite the good news, Mr Obama's approval ratings, though high, are slipping. This, in part, is because even with July's drop, unemployment remains surprisingly high. It usually responds to economic growth in a relationship that was captured by an economist, Arthur Okun, in the 1960s. But it has risen more during this recession than most formulations of Okun's Law would suggest.

The publication of revisions to earlier GDP data explains some of the discrepancy. The revisions show that GDP has declined a cumulative 3.7% since the end of 2007, thus tying with 1957-58 as the deepest recession since the Depression (before these revisions, the decline was shown to be 2.5%). Even so, Michael Feroli, an economist at JPMorgan Chase, says that Okun's Law would have predicted an unemployment rate of just 8.6% during the second quarter, whereas it actually averaged 9.3%.

Several factors are at work. Expanded unemployment-insurance benefits encourage some workers to keep looking for a job rather than drop out of the workforce altogether, adding perhaps half a percentage point to the unemployment rate, according to the Fed. The evisceration of their wealth may have led people to look for work rather than retire or stay at home with the children. The drop in July's unemployment rate hints at a reversal, though possibly temporary, of such trends since it was driven not by higher employment but by fewer people looking for work. Otherwise, the rate would have risen to 9.7%, HSBC estimates.

And firms have been unusually quick to slash payrolls. Some may be husbanding cash more carefully because of the credit crunch. Others may simply be more pessimistic about an eventual recovery. Whatever the reason, one result is that productivity is rising, cushioning profit margins. Robert Hall of Stanford University, who heads the academic committee that dates recessions, says Okun devised his law in an era when productivity usually fell during recessions: “When productivity rises, the law fails. Though I was a great fan of Okun's, I'm afraid his law is obsolete.”

The difference with Europe is especially striking. In the euro zone GDP has fallen further than in America but unemployment has risen less. Employers are slower to sack workers than in America, partly thanks to government subsidies that encourage them to shorten working hours instead. This means that European unemployment will probably be slow to fall once GDP recovers.

But it looks as if it will be slow to come down in America as well. Firms are unlikely to do much hiring until growth seems durable, and so far it does not. Replenishing inventory will be a temporary fillip without an increase in consumer demand, for which there remains scant evidence.

Car sales have been strong in great part because of the federal cash-for-clunkers programme, which allows Americans to get up to $4,500 for their old car when they exchange it for a new one. The programme was supposed to run until November 1st but its $1 billion was snapped up within days of its start on July 24th. Both houses of Congress have authorized for an extra $2 billion. But cars bought now may mean fewer cars bought later.

If growth peters out again later this year, it will dash the expectations Mr Obama has done so much to raise by touting his stimulus.