|New York TIMES/December 5, 2005
What's Ahead: Blue Skies, or More Forecasts of Them?
By DAVID LEONHARDT
The nation's economic forecasters are all but unanimous in predicting
that the coming year will not bring a recession. It isn't so clear,
however, whether that forecast has any meaning.
Wall Street economists are notorious for insisting that all is fine
even when a downturn is just around the corner. The few pessimists who
regularly prophesize doom are only occasionally right.
Even the actual start of a recession does not always help. Alan
Greenspan, the chairman of the Federal Reserve, spent much of early
2001 saying that a recession was avoidable. In fact, one had already
Trying to predict recessions - an effort that drives much of
forecasting - turns out to have little practical use. The more
relevant question might be whether growth is likely to speed up or
slow down in the coming year, and most of the signs, like still-high
energy costs and a cooling housing market, are pointing to a slowdown.
Slowing economies matter because they often set the stage for
recessions, and they usually drag down stock prices in any event. By
the time a recession begins and job losses are mounting, stocks are
frequently rising again.
"The recession obsession is a terrible mistake," said Joseph H. Ellis,
a former partner at Goldman Sachs who was ranked the country's top
retail analyst for 18 straight years by Institutional Investor
magazine. "We need to find a way to talk about slowing rates of
growth. We need new language."
In a new book, "Ahead of the Curve" (Harvard Business School Press,
2005), Mr. Ellis argues that the economy's direction is easier to
divine than many people think. Cast aside the recession obsession,
look beyond the torrent of confusing data each week, he says, and you
can often tell what the economy's next move will be. You still won't
know when the next recession is coming, but neither do Mr. Greenspan
or Wall Street's prophets.
In 2006, Mr. Ellis says, the economy will probably slow more than most
forecasters predict, for the same important reason it has typically
slowed at other points in the last 40 years: weak wage growth.
The forecasters polled in a regular survey by the Philadelphia Fed say
they think that the economy will expand 3.4 percent next year, down
from 3.6 this year. To Mr. Ellis - who is also the founder of Blue
Tulip, a chain of gift and paper stores in the Northeast - 2 percent
growth might be more likely.
"We're probably past the peak," he said.
The key to his system is paying attention to people's paychecks and
comparing them with inflation. These checks receive less attention
than the unemployment rate or job growth, but they are far more
important to the economy.
Only a fraction of workers lose their job in a given year. But all
workers get paid, and the changes in their pay help determine consumer
spending. Consumer spending, in turn, makes up about two-thirds of the
$12 trillion American economy. Where it goes, industrial production,
capital spending and hiring eventually follow.
For most of the last two years, wages of rank-and-file workers - about
80 percent of the work force - have been growing more slowly than
inflation. Upper-income households have done better, but surging
energy costs this year have dented their buying power as well.
In the 12 months ending in November, the weekly pay of rank-and-file
workers fell about 0.5 percent, after taking inflation into account,
according to the Bureau of Labor Statistics. (Annual rates of change
like this are another of Mr. Ellis's fixations; the month-to-month
changes that are often reported by the news media are much too noisy
to be useful, he says.)
Just about every other time that inflation-adjusted pay growth has
slowed in recent decades, consumer spending eventually took a hit,
too. The big exceptions came after tax cuts, such as the ones proposed
by President Reagan in the early 1980's and by President Bush during
his first term. But the current federal budget deficit makes another
tax cut unlikely next year.
Wage growth has not been a perfect economic predictor, of course.
Nothing is. Corporate investment and international trade also matter.
And forms of income other than regular wages, like bonuses and stock
options, are bigger than they were in past decades. They helped keep
the economy growing at a surprisingly healthy pace in 2004 and 2005
despite high energy costs and lagging wages.
The figures that Mr. Ellis tracks "are only part of the story," said
James O'Sullivan, an economist at UBS. "You've had a pretty clear
pattern where total wage-and-salary income has been consistently
It is also possible that the recent tax cuts and real-estate boom have
carried the economy through its danger zone. Nominal wage growth -
that is, before accounting for inflation - picked up this year as the
job market improved. Oil prices have recently fallen, which suggests
that Mr. Ellis's favorite indicator - inflation-adjusted wages - might
be on the verge of turning around.
Still, the economy has rarely escaped pain after years of slowing real
wages, even if there is sometimes a lag. Mr. Ellis began to use his
system at Goldman Sachs in the early 1970's, and it played a big role
in his success as a retail analyst.
It also earned him needling when he strayed from Wall Street's usual
sunny forecasts. Slowing wage growth started worrying him in late
1998, for instance, but friends told him that the wealth that had been
created by the long bull market would keep the economy booming.
They did, but only temporarily. Rising house values might well have
played a similar role in the last couple years. "These things can
postpone a decline" in spending growth, he said, "but they can't
If Mr. Ellis is wrong, he will have picked a bad time to commit his
ideas to paper. If he is right, Wall Street's forecasts next December
will revolve around the question of whether the slowdown of 2006 will
become the recession of 2007. You can guess what their answer will be.