– Crystal ball gazing by Economists

Last updated on: December 6, 2005 at 2:39 pm by Desh Kapoor

– Crystal ball gazing by Economists 2005-12-06T14:39:42-06:00 Desh Kapoor

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Here is some crystal ball gazing from the economists on how the economy will shake up!

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 stronger.”

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 prevent it.”

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