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Prior to jobs, we learned that, even though personal income in June increased 0.5% and the Conference Board’s consumer confidence index unexpectedly rose in July, consumer spending remained very weak. Annual growth in personal income slowed to just 3.5% in June from 5.1% a year earlier, and revisions lowered the level of income in 2009-2011. Confidence remains at historically low levels, battered by European debt problems, weak job growth, and increased political rhetoric around the impending fiscal cliff—tax increases and spending cuts scheduled to take effect at the end of this year, before the next President and new Congress take office. Households in both the U.S. and Canada are fretful and stingy, even as mortgage rates hit record lows.

Given that consumer spending accounts for about two-thirds of demand, the growth outlook is dimming for the third quarter and possibly beyond. Businesses are plagued by those same concerns and, in the U.S., are reticent to increase payrolls the way they have in past recoveries. In Canada, the global slowdown and ensuing drop in oil and metals prices have pinched activity in the once red-hot commodity sector. At least some farmers in Canada will benefit from higher corn and grain prices because of the horrendous drought in the U.S. Midwest. The U.S. is posting the slowest recovery and expansion in the postwar period. Fiscal drag is part of the reason. The recession rebounds that occurred in the Reagan, Clinton and Bush eras all were accompanied by government spending increases. In the Obama recovery, total public outlays have fallen 1.5% compared to a 1.9% average yearly gain in the previous five expansions.

The cutbacks are most pronounced at the state and local levels, having gone on now for 11 consecutive quarters, leading spending to contract at a 2.4% rate since the second quarter of 2009. Slower federal spending has also become a drag on growth, contracting at a 0.2% annualized rate. Congress will most likely postpone the fiscal cliff decisions for three months until the new government takes control. But clearly, both Parties are committed to deficit reduction through spending cuts and possible tax increases. As I noted last week, median family income in the U.S. is lower today than 12 years ago, a stretch unlike any other since the 1930s. Since 2000, median real family income in the U.S. has fallen roughly 6%, while rising 8.8% in Canada.

In last week’s note, I attributed the relative U.S. weakness to global competitive pressures, diminished union power, outsourcing, record post-crisis layoffs, collapsing housing markets, the banking crisis, tax cuts for the rich and the growth in corporate profits relative to wages. The economic pie was shrinking while income distribution widened, putting a squeeze on the middle class. Several of our clients wondered how much of the unemployment is voluntary to the extent that long-term unemployment insurance discourages job search, particularly for lower-paying jobs. The question raised was: how many job openings go unfilled for this or other reasons? We do have data that help us answer the question, but some of the evidence is anecdotal. The Labor Department recently released the May monthly survey on job openings and labor turnover, known as the JOLTS report. The number of U.S. job openings increased to 3.6 million in May, up from 3.4 million in April. So did the number of layoffs, from 1.7 million to 1.9 million—the highest level in two years. With 12.8 million people out of work, that still means there are 3.5 people for every job opening. Not good. A healthy ratio is usually around 2 to 1. Job openings vary greatly by region.

They are more plentiful in the Midwest owing to the strong automotive and energy sectors. The greatest relative need for labor is in North Dakota, where the shale oil industry is booming. Keep in mind that the JOLT data are imprecise with a large margin of error, but labor is less mobile this cycle because of the housing market collapse. It’s harder to move to where the jobs are if you can’t sell your house. Also, there is a skills mismatch as not everyone can help in shale oil or automotive production. Many businesses simply can’t find skilled labor.

There are insufficient numbers of scientists, engineers, geologists, programmers and experienced health care workers. However, this is a relatively small factor as, according to the July survey of independent businesses, only 15% of business owners responded that job openings are hard to fill, a decrease of 5% since May. Chairman Bernanke believes that most of the unemployment is cyclical rather than structural. In other words, if the economy were stronger, the unemployment rate would be significantly lower. As output and incomes fall, job vacancies decline and unemployment rises.

There is an inverse relationship between job openings and unemployment. Movements along this curve are caused by changes in the cycle (expansion to recession or vice versa). But shifts in the curve are the result of structural changes in the economy. For example, if the curve shifts to the right, as many posit, there are more unemployed people for any given number of job vacancies. This could be caused by, for example, an increase or lengthening in unemployment insurance payments or the rapid growth in a new sector leading to greater skills mismatches. Empirical analysis by the Fed suggests that there has been some outward shift in this curve (known as the Beveridge curve) during the recession.

However, after more in-depth study, the Fed staff concluded that the same thing happened in the deep recessions of 1973-to-1975 and 1980-to-1981, but in both cases it was temporary. The curves shifted inward during the recovery. To be sure, labor force participation rates have fallen to multi-decade lows in the U.S. this cycle. Many workers are too discouraged to look for work and are therefore no longer considered unemployed by the widely reported unemployment rate (technically called U3), which has been stuck around 8.2% this year. Adding in discouraged workers to both the numerator and denominator [1], yields a rate of 8.8% (U4). The number jumps to 9.7% (U5) if you include “all other marginally attached workers.” The broadest measure of unemployment, U6, adds to U5 those who are involuntarily working less than full time. This jobless rate is a whopping 15%—down from a record-high 17.2% in October 2009. Bottom Line: There is no way to know how many of the approximately 24 million unemployed workers in the U.S. (under the broadest measure) are holding off looking for, or accepting a job, because they are receiving unemployment insurance. There are now roughly 2.5 million labor force dropouts (discouraged and marginally attached workers); they cannot receive unemployment insurance benefits because you must be actively looking for work to do so. Do social safety nets such as unemployment insurance and food stamps encourage joblessness? My conclusion is that, at the margin, it might to some degree. A lawyer, for example, might not take a job selling shoes until his or her UI runs out and is desperate. However, UI payments are hard to live on for anyone who had a good-paying job. Certainly, the economy would be in much worse shape today if such government programs did not exist.

[1] Persons marginally attached to the labor force are those who currently are neither working nor looking for work but indicate that they want and are available for a job and have looked for work sometime in the past 12 months. Discouraged workers, a subset of the marginally attached, have given a job-market related reason for not currently looking for work. Persons employed part time for economic reasons are those who want and are available for full-time work but have had to settle for a part-time schedule.