Wall Street Is Underestimating the Economic Recovery

(Bloomberg Opinion) -- The U.S. remains in a deep employment hole, with 6.7 million fewer jobs in June than there were in February 2020. But that overstates the weakness in the economy, with last week's second-quarter gross domestic product report showing American output is back at an all-time high. Last week's personal income report showed worker incomes are at all-time highs as well. What this divergence suggests is that a return to full employment will mean a higher level of output and worker incomes than is now appreciated, opening up a path for the economy to grow at a faster rate over the next several years than it did in the 2010s.

The elegant way to show this numerically is to look at the change in real GDP, employment, and wages and salaries received by workers between December 2019 and June 2021. Real GDP has increased by 0.8%. Employment is down by 4.1%. And wages and salaries received by workers are up by 6.7%. Employment and wages aren't apples to apples — the headline consumer price index level has increased by 4.9% over that time period, so "real wages and salaries" is up by a little less than 2%, but it still shows that real output and real wages are at new highs while employment remains well below its high.

There are a few different reasons for this. The first is that a lot of jobs lost during the pandemic and not recovered yet are in lower-paying industries such as leisure and hospitality, so that has a bigger impact on employment than on wages or GDP. The second is that over the past several months, employers have had to raise wages to staff up during the reopening of the economy, so wages are now rising more rapidly than employment. For instance, wages and salaries have grown by 2.3% over the past 3 months while employment has only expanded by 1.2%. A third factor is that productivity growth has been strong, which is a typical dynamic coming out of recessions because companies become more efficient during downturns.

The upshot is that right now we have an economy that's completed its recovery on an output basis but is still in a deep hole on an employment basis, which is good news to the extent we believe we can have a full employment recovery. Right now Wall Street firms like Goldman Sachs Group Inc. are forecasting real GDP growth will slow to a run rate of 1.5% to 2% by the latter part of 2022, which they believe is a trend-like rate of growth reflecting the longer-term fundamentals of the economy.

That seems like an extremely conservative forecast based more on GDP than employment. A 4% employment shortfall would be more like 6% when thinking about all the additional jobs we might have added if not for the pandemic — after all, employment was growing at an annual rate of around 1.5% heading into 2020. And it's possible that productivity growth is going to be structurally higher as companies invest in automation in response to wage growth for lower-paid service workers, and as white-collar firms restructure themselves to account for remote and flexible work.

To assess potential output growth without theoretical constraints on the economy, imagine it takes another 18 months, or the end of 2022, to get employment back to its pre-pandemic trend — filling that 6% employment hole and adding another 2% through the end of 2022. And then imagine productivity growth averages 2% for the next 18 months from automation and companies gaining efficiencies from hybrid work arrangements bring another 3% in output. That would mean around 11% in real GDP growth by the end of 2022, or an annualized rate of 7% sustained at least through the end of next year.

That shouldn't be anyone's base case — we've seen how much supply chain problems have held back growth over the past few months, so even if all those people are put back to work again there might be other constraints in the short-term. But if full employment is a better gauge for the recovery and a return to trend, it means a lot more potential output and worker income is possible than a GDP-centered model would suggest. This economy should be able to sustain stronger rates of growth than we're used to for quite some time, with pandemic-related changes unlocking gains that might not have occurred otherwise.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Conor Sen is a Bloomberg Opinion columnist and the founder of Peachtree Creek Investments. He's been a contributor to the Atlantic and Business Insider and resides in Atlanta.

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