Johnson: Deficit Reduction Days Are Over

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm joined today by Bob Johnson, our director of economic analysis, to look at some new data.

Bob, thanks for joining me.

Bob Johnson: Glad to be here today.

Glaser: Let's start with the federal budget deficit. This has come down considerably since the height of the recession. But other signs indicate that maybe there's not so much progress being made these days.

Johnson: You're right. The progress has been dramatic over the years. We've gone from well over a trillion-dollar deficit to a $500 billion deficit. We've more than cut it in half. That's been great news.

Unfortunately, it looks like maybe some of that is coming to an end, at least some of the dramatic improvement. We came down just a little bit last year, but not much for the full year. Now we've got the first two months of fiscal 2016, and the deficit is about $20 billion higher than it was in the prior year. But there were some special factors in there. Nevertheless, maybe the days of rapid improvement are over, and what will happen is that the deficit will stay relatively constant as GDP grows. So, as a percentage, we'll still be OK for a few years. But certainly, the best is over right now for a number of reasons.

Glaser: What does this mean for the economy then? Are we going to see less of a drag from lower government spending? What's your outlook there?

Johnson: Spending was up a little bit more than it had been. It was up about 6% in terms of spending for the first two months. Now, a bunch of that is in the transfer payments, which really don't help GDP in the same way as buying an aircraft or building a building. But nevertheless, spending was up. So, that is better news for the economy, because government has been one of the real laggards in contributing to the slow GDP growth. In fact, GDP growth would look almost normal if government grew at its normal amount. Now we've got just a little bit of an add in the first couple of months, and we'll have to see if that's sustainable.

Now, on the other side of the house, one of the reasons that the deficit went wider by as much as it did was because corporate tax collections were weaker. The reason is that last year there was a great deal of uncertainty, and this year there actually was a little bit, too. But last year everybody was rushing to pay their taxes because they thought the R&D tax credit was not going to be extended. So, they had to rush in last-minute payments. This year they still haven't said what they'll do, but nobody is anticipating that it won't happen, so we are not getting these big flows of cash. So the deficit, at least for these first couple of months, looks worse because the tax collections are lower on the corporate side.

Glaser: Turning from the federal government to small businesses, we got a peek at small-business optimism. How are they feeling right now?

Johnson: Not as optimistic. We've been running at 96 or so, adding a little bit for a couple of months in a row. The long-term average is 100. This month we dropped back to 94. It was a disappointing month for small businesses. But there are a number of reasons why that may be.

Glaser: Let's look under the headline number. What's happening with the labor market in small business?

Johnson: That's one of the interesting things to look at in this report. Sometimes the headline number is more of a sentiment: How are they feeling today? What's in the headlines? But some of the detailed data is of interest, and especially the labor market data. There we focus on two things: The percentage of job openings that are hard to fill, and that number continues to remain in the high 40s. So, clearly, the job shortage thesis that we've developed over time is showing up in spades, and small-business owners are finding it increasingly hard to find the right skill sets to fill their positions.

Glaser: Are they paying more, then, to do this?

Johnson: That's another interesting thing. One number that really jumped out of the report is the percentage of businesses that expected to raise salaries in the next month or two. That number was at a recovery high of 20%. So, in a world where there isn't a lot of inflation and where they haven't got much ability to raise prices [of their products], that's a pretty hefty number. So, we were very surprised by that number, and it's certainly beginning to show the underlying wage pressures that are building in the economy. Now, we've slowly seen it in some of the hourly wage data, but there are so many things combined in there, and mix issues, that sometimes it's hard to see. But the small-business owners are clearly telling us that they are having to pay up. But by the way, they aren't able to fully raise prices to cover all of that, which might explain why they are less than totally happy and why that sentiment index is down a little bit this month.

Glaser: Speaking of the labor market, job openings were down slightly. What do you think this says about the state of the labor market? Do you still see positive signs here?

Johnson: You've always got to watch the month-to-month and the revisions on these numbers. We were at 5.5 million openings, and it dropped to 5.38 million, so not a big swing in the number whatsoever. It's been over that 5.2 million range since April. So, it's still a very strong number, but it wasn't quite as powerful as it was in some earlier months.

But nevertheless, over the last year, we've added about half a million openings, or roughly 10%. And you'll recall hiring is growing at a much slower rate than that. That gap still continues, and what's particularly interesting is the number of unemployed has fallen by over a million over that same time.

One of the ways we economists like to look at labor market pressures is, how many openings are there and how many are available? How many people are unemployed? And the number of unemployed has come down by a million people over the last year. Openings have gone up by about half a million. So, if you think about it, the ratio has really fallen dramatically from about 2 to 1.5 unemployed workers for each opening, which really indicates labor markets are getting tighter in a hurry.

Glaser: Is this a sign that there is some labor market mismatch going on? That you have a lot of workers but that maybe they're not qualified or in the right place to do these jobs?

Johnson: There are so many things. It can be a geographic issue, where there aren't enough people in certain locations; that's certainly a little bit of the puzzle. In other words, somebody is unemployed in Houston from the oil industry. Are they going to pick up everything and move to San Francisco because there are worker shortages there? I don't think so. So, you've got some geographic mismatch going on right now, but we've had that for a while, and now actually some of the weaker markets are getting stronger and the stronger markets are getting weaker.

You've also got a company that wants a computer programmer, but the guy is a newspaper writer. So, you've got that mismatch of skills, and can people be retained? Slowly and over time I think so, but that's part of the structural issue that we're seeing out there.

And another big part of it is that employers feel trapped. They don't want to pay a fully going wage where they could attract people because they aren't able to raise prices. So rather than grow their business, they are making the conscious decision: "Oh, well, I won't fill this position" rather than really paying up for it, because I can't afford to raise my prices. So, that's another thing that's going on in the data that complicates the analysis of it.

Glaser: Bob, I appreciate the analysis today.

Johnson: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.