competitiveness & expectations

22
© 2012 Bridgewater Associates, LP. Any publication or other use (including, without limitation, distribution via email or any internet posting) of Bridgewater Daily Observations™ without prior written consent from Bridgewater Associates, LP is prohibited by U.S. and foreign copyright laws. Bridgewater® is a registered service mark of Bridgewater Associates, LP. All rights are reserved. 1 Bridgewater ® Daily Observations 10/31/12 Bridgewater ® Daily Observations October 31, 2012 ©2012 Bridgewater Associates, LP (203) 226-3030 Ray Dalio Bob Elliott Mark Dinner Jacob Kline Formula for Economic Success As you know, we think the economy works like a machine and we think of ourselves as practical mechanics – or, if you prefer, we think it works like a body and we operate like a doctor. We believe that there is no point – in fact we think it’s dangerous and costly – to wish the economy works some way differently than it really does. Too often we hear people say “I believe…” based on adherence to a belief system and without substantiating why they have that belief. We don’t want to do that. We think that it is our responsibility to clearly explain how the economic machine works by describing the cause/effect relationships that make it up, and to do that for everyone to examine and poke at. We know that we all will learn more that way. To us the existing discussion about what should be done to make our countries successful lacks the specificity and the testing of predictability that is necessary to make the discussion useful. For example, everyone knows that having a more educated population is better than having a less educated population, so naturally we hear that improving education is important to improving competitiveness. However, measurements of the value of education are lacking. If we simply educate people without considering the costs and paybacks of that education, we will waste resources and become less competitive even though we will become more educated. So the productive value of the education in relation to its costs is a more sensible way of measuring it. When measured, we should see how predictive it is. What are the Keys to Success? Its seems intuitively obvious, and is in keeping with our experiences as a practitioners operating in many countries over several decades, that four factors drive relative growth: they are competiveness, indebtedness, culture and luck. In a study that we did that we will send you shortly, we will show how we measured each of these and how they predicted subsequent growth, so we won’t go into that now. However, we would like to now have you focus on one of the components of our “Formula for Economic Success” – self-sufficiency – because we think it’s interesting enough to stand on its own. Self-Sufficiency It is both logical and consistent with the evidence to believe that self-sufficiency is an important ingredient for individuals and societies to be successful. Self-sufficiency encourages productivity by tying the ability to spend to the need to produce, it allows people to be free rather than dependent on others and it gives people self-respect. It is not controversial to say that people spend the money that they earn differently than the money that others give them – i.e., that the connection between earning and spending is a healthy one. If people have to earn money to spend it, they have to be more productive. Over the long run increases in living standards rise as a function of increases in productivity. So, it is not a big leap to presume that countries with greater amounts of self-sufficiency

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Emerging Markets Compete due to their innact NEED TO INNOVATE AND PRODUCE vs the welfatre state of Europe and now America.

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Page 1: Competitiveness & Expectations

© 2012 Bridgewater Associates, LP. Any publication or other use (including, without limitation, distribution via email or anyinternet posting) of Bridgewater Daily Observations™ without prior written consent from Bridgewater Associates, LP is

prohibited by U.S. and foreign copyright laws. Bridgewater® is a registered service mark of Bridgewater Associates, LP.All rights are reserved.

1Bridgewater® Daily Observations 10/31/12

Bridgewater®

Daily ObservationsOctober 31, 2012 ©2012 Bridgewater Associates, LP

(203) 226-3030 Ray DalioBob Elliott

Mark DinnerJacob Kline

Formula for Economic Success

As you know, we think the economy works like a machine and we think of ourselves as practicalmechanics – or, if you prefer, we think it works like a body and we operate like a doctor. We believethat there is no point – in fact we think it’s dangerous and costly – to wish the economy works someway differently than it really does. Too often we hear people say “I believe…” based on adherence toa belief system and without substantiating why they have that belief. We don’t want to do that. Wethink that it is our responsibility to clearly explain how the economic machine works by describing thecause/effect relationships that make it up, and to do that for everyone to examine and poke at. Weknow that we all will learn more that way.

To us the existing discussion about what should be done to make our countries successful lacks thespecificity and the testing of predictability that is necessary to make the discussion useful. Forexample, everyone knows that having a more educated population is better than having a lesseducated population, so naturally we hear that improving education is important to improvingcompetitiveness. However, measurements of the value of education are lacking. If we simplyeducate people without considering the costs and paybacks of that education, we will wasteresources and become less competitive even though we will become more educated. So theproductive value of the education in relation to its costs is a more sensible way of measuring it. Whenmeasured, we should see how predictive it is.

What are the Keys to Success? Its seems intuitively obvious, and is in keeping with ourexperiences as a practitioners operating in many countries over several decades, that four factorsdrive relative growth: they are competiveness, indebtedness, culture and luck. In a study that we didthat we will send you shortly, we will show how we measured each of these and how they predictedsubsequent growth, so we won’t go into that now. However, we would like to now have you focus onone of the components of our “Formula for Economic Success” – self-sufficiency – because wethink it’s interesting enough to stand on its own.

Self-Sufficiency

It is both logical and consistent with the evidence to believe that self-sufficiency is an importantingredient for individuals and societies to be successful. Self-sufficiency encourages productivity bytying the ability to spend to the need to produce, it allows people to be free rather than dependent onothers and it gives people self-respect. It is not controversial to say that people spend the money thatthey earn differently than the money that others give them – i.e., that the connection between earningand spending is a healthy one. If people have to earn money to spend it, they have to be moreproductive. Over the long run increases in living standards rise as a function of increases inproductivity. So, it is not a big leap to presume that countries with greater amounts of self-sufficiency

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do better than those with less. Since self-sufficiency creates capability and independence it producesself-esteem. Studies on happiness have shown that once income levels surpass those required forsubsistence, that these factors are more highly correlated with happiness levels than the amount ofmoney one has. For these reasons, it is logical to conclude that self-reliance is both productive andsatisfying.

In this Daily Observations we will show you how self-sufficiency varies by country and how it hasbeen correlated with economic growth. You will see that there are significant divergences in how self-sufficient individuals are in different countries and that these differences occur for different reasons.For example, in some cases they are chosen (e.g., the amounts of transfer payments developedeconomies have are largely chosen) while in other cases that they are not (e.g., high self-sufficiencyin the poorest societies is primarily the result of necessity rather than choice). Nonetheless, theevidence is clear. Societies in which individuals are more responsible for themselves grow morethan those in which they are less responsible for themselves. To be clear, by self-sufficiency, we donot necessarily mean leaving people on their own. Cases in which people are helped to stand ontheir own and the help proves to be cost-effective encourage growth.

Which Countries Are Most Self-sufficient and How Has Self-sufficiency BeenCorrelated With Growth?

To determine the answer to these questions we created indicators which we aggregated into a self-sufficiency barometer. We will explain how we did that and what the individual indicators showed, butto cut to the chase:

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Which countries are most self-sufficient?

The chart shown below conveys those which are most-self-sufficient. As shown, Asian economiesare measured as most self-sufficient, followed by Latin American countries. The English speakingdeveloped world generally comes next. Finally, European countries, with the large Europeanperiphery countries like Spain and Italy, are the least self sufficient. The chart below shows theseratings. Look at it to see if you are surprised and note those surprises so that you can see what theyare attributable to when we show you the composition of our barometer. For example, you might findit notable that “communist” China has greater self-sufficiency than the capitalist US.

TLDSGPINDMEXKORCHNHKGIDRTAIPHPCOLJPNCHEUSARUSAUSBRZARGCANNZLGBRSAFNLDCZKVEZPLDPRTNORDEUGRCHUNIREESPFRAITASWEBEL

Aggregate Self Sufficiency Indicator (Z-Score)

-2.5 -2.0 -1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5

EM Asia is generally at the top…

…English speaking developed world,Switzerland and Japan are most self sufficientin the developed world.

…Europeans are generally the least selfsufficient

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How is this self-sufficiency barometer constructued?

To measure self-sufficiency, we look at 9 indicators related to 1) how hard individuals work, 2) howlarge government supports are relative to incomes, and 3) how rigid labor markets are (e.g., howeasy/difficult it is to hire and fire). While no one of these perfectly measures self-sufficiency, togetherthey paint a picture that is highly indicative.

Our measures of working hard look at how many hours individuals actually work, the percentage ofthe population that is looking to work (labor force participation), the amount of vacation and holidaysthey take, as well as the effective retirement age. We measure the size of government supports bylooking at the size of government outlays and the size of transfer payments to households. Finally,we look at three measures to examine labor market protections: unionization as a percentage of theworkforce, how hard it is for businesses to hire and fire, and how high the minimum wage is relative tothe average income. To come up with an overall gauge, we weigh 50% our measures of how hardindividuals in a society work and 50% the system of supports and protections, i.e., 25% forgovernment supports and 25% for labor market rigidity. Within each gauge we mostly give equalweight to the individual indicators.

Self-Sufficiency Indicators and Growth WeightIndicatorAggregate Self-Sufficiency Indicator

Hard Working 50%Average Hours Worked 25%Labor Force Participation 8%Effective Retirement Age (% of Life Expectancy) 8%Actual Vacation + Holidays Per Year 8%

Government Support 25%Transfer Payments to HH, %PGDP 13%Gov Outlays as % of PGDP 13%

Rigidity of Labor Market 25%Unionization as % of Workforce 8%Ease of Hiring/Firing 8%Minimum Wage as % of Average Income 8%

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How well does a country’s self-sufficiency predict its next ten year’s growthrate?

To answer this question we gathered these indicators and put them together into the previouslyshown gauges and constructed this barometer in past years so that we could see how well theycorrelated with subsequent period growth rates. We saw that the most self-sufficient countriesnotably outperformed the less self-sufficient ones, with an the overall correlation of about 43% tosubsequent 10-year real growth in income per capita across all countries and time. As you will see inour subsequent study, other measures of competiveness, indebtedness, culture and luck explainedmost of the rest. Self-sufficiency is a reasonably good predictor of growth in both the developed andemerging worlds when looked at on their own (33% and 39% correlated, respectively). Below weshow the relationship of our aggregate self-sufficiency indicator against future growth for all countriesacross time. We then show the relationship of our individual guages and indicators to subsequentgrowth. Our data set includes over 40 countries since 1960.

`Self Sufficiency Against Future Growth

Correl. = 43%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

-2 -1.5 -1 -0.5 0 0.5 1 1.5 2 2.5 3 3.5

Developed

Correl = 33%

-2%

0%

2%

4%

6%

8%

10%

-2 0 2

Emerging

Correl = 39%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

-2 0 2

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Looking at the individual indicators, we see that government supports and working hard both have amoderate correlation to future growth across time, of about 38% and 26% respectively. Among theindividual indicators, average hours worked is one of the most strongly correlated with growth acrosstime, 40%, followed by government outlays, 26%. Government transfers have a high correlation withfuture growth, though our dataset for this indicator is more limited and will have some bias because ofcountries with lower growth having higher transfers. Still a causal relationship is intuitive to us. Labormarket rigidity and its component measures have shown the lowest empirical relationship to growthusing our measures, though this is where our back history is most limited.

More Depth on the Individual Indicators of Self-Sufficiency

Below we show 1) how our individual indicators of self-sufficiency have correlated with subsequent10-year real growth in income per capita and 2) where countries stand on these measures today. Westart with those indicators that have been most correlated with (predictive of) subsequent growth andgo to those which have been least. Since our government support indicators have been mostpredictive, we will start with them.

Government Supports

Government supports, directly through transfers that redistribute incomes or indirectly throughservices, are the primary means of enabling individuals to consume more than they earn. To beclear, we aren’t arguing for or against such payments; we are just measuring self-sufficiency and,since this is one of the biggest influences on it, it is a significant part of our gauge. All else beingequal, countries that have fewer transfers, smaller welfare systems and more limited social servicesthan those societies that have larger ones grow faster. In aggregate, our government supportsindicator is -38% correlated with future growth of countries through our dataset.

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Turning first to outlays, we see many of the emerging Asian countries have very small governmentsrelative to the size of their economies. Singapore’s government spends close to 15% of GDP, andChina's government doesn't spend that much more, about 20%. India is a bit lower down but still inthe top quartile, with government spending around 25% of GDP. There is some variation with LatinAmerican countries, with Mexico’s government outlays at less than 25% of GDP, and Argentina andBrazil’s governments closer to 35 to 40%, around the middle of the pack. Japan and the US are alsoin the middle. France and Italy are on the other end of the spectrum. Their governments spendbetween 50% and 55% of GDP. Over time this measure is -26% correlated with future growth.

SGPHKGPHPIDRCHNKORTLDTAIMEXINDCOLECDCHEAUSARGRUSVEZJPNBRZUSACANESPNZLGBRPLDCZKPRTDEUIRENORGRCNLDITAHUNBELSWEFRA

Government Expenditures (% of PGDP)

15% 20% 25% 30% 35% 40% 45% 50% 55%

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Turning to transfers, we see that India and China’s governments are the least redistributive, by ourmeasures. In both countries transfers to households are around 5% of GDP. Transfers in the USand Japan are about four times larger, around 20% of GDP respectively, but still much lower relativeto the rest of the developed world. In Western Europe and Scandinavia, transfers range from a bitunder 25% to nearly 30% in France and Sweden. As mentioned, transfers have a high correlationwith future growth in our sample, though our dataset for this indicator is more limited and will havesome bias because of countries with lower growth having higher transfers.

INDCHNSAFKORRUSBRZAUSUSACANJPNCHENZLNLDNORGBRGRCHUNESPPRTITADEUBELSWEFRA

Government Transfers to Households (% of PGDP)

0% 5% 10% 15% 20% 25% 30% 35%

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Hard Working

Societies that are self-sufficient have a high percenage of their population working hard each day tobe self-reliant. People who work hard both produce more in the near-term and generally grow fasterthrough time than those who opt more for leisure (i.e. it impacts the rate of change not just the level ofdifference today). Below we look at a variety of measures to get a sense of how many individuals areworking and how hard and also how that has related to future growth in the past. In aggregate ourhardworking indicator is 26% correlated with future growth of countries through our dataset. As wewill see in a report that will soon be released, those in lower-income countries work harder and, allthings being equal, those in lower-income countries are prone to grow faster.

The indicator most correlated with future growth is average weekly hours of actual work. Regretablywe must look at this measure for just men in the labor force because different social norms acrosscountries around women in the workfoce distort the numbers, and we must adjust for things like laborforce participation, vacation time and holidays. When we scan across countries, we see emergingcountries at the top of the list, including China, Mexico, and India. Overall, emerging Asia comesthrough as working the hardest, followed by Latin America. Among rich countries, Singapore andthen Japan have the hardest workers. The US is fairly hard working among developed countries,wheras workers in Europe appeare to opt for leisure more than anyone else based on thesemeasurses. Over time this measure is 40% correlated with future growth. In the last 10 years thecorrelation has been similar, 49%.

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Labor force participation is an indication of how much a society wants to work. By and large theemerging world has much higher male labor force participation rates than the developed world,though there are exceptions. Brazil, India, Mexico and China have some of the highest labor forceparticipation rates (all above 80%). There is still a high participation of men in the workforce inSingapore and Switzerland (around 75%), despite the wealth of these countries. Japan has one of thehighest male labor force participation rates among developed countries (above 70%). This measureis a bit lower in the US, UK and Commonwealth countries. Labor force participation is lowest amongmen in Western Europe, particularly Italy, France and Greece (60% to 65%), though Germany andSpain are not far behind, along with parts of Eastern Europe, especially Hungary, which is at thebottom of the list. Over time this measure is 14% correlated with future growth. In the last 10 yearsthe correlation has been higher, 40%.

PERIDRECDBRZINDMEXCHNVEZTLDCOLPHPMALSGPCHEARGCHINZLAUSJPNKORNLDCANTURRUSNORUSAGBRHKGIRESWECZKPRTESPTAIDEUGRCPLDFRABELSAFBGLITAHUN

Labor Force Participation (% of Working Age Population)

55% 60% 65% 70% 75% 80% 85%

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The picture isn't that different looking at vacation time. Japanese workers appear to take very fewvacations (less than one week per year on average), consistent with a strong work ethic reflected inour other measures. India and China are toward the top of the list, with the average vacation timearound two weeks per year. The norm in the US is about three-and-a-half weeks. German, Frenchand Spanish workers appear to take the most vacation, with Italy and Greece not far behind. Onaverage, Europeans appear take 6 to 7 weeks of vacation per year. In the last 10 years thecorrelation with future growth has been 25%.

JPNKORAUSMEXSGPINDCHNNZLUSACANRUSBRZNLDCHEIRENORPLDHUNCZKGRCITABELPRTGBRSWEESPFRADEU

0.0 1.0 2.0 3.0 4.0 5.0 6.0 7.0

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Another measure of how hard individuals work is how long they work before retirement. Wemeasured this by looking at the effective retirement age as a percentage of life expectancy. Thepicture shows some notable differences with the earlier patterns we saw. While the countries at thetop are mostly emerging, Japan and the US are ahead of many low income countries. Japanese andUS workers appear to work 85% or more of their life expectancy before retiring. On the other hand,workers in China retire much earlier, having worked closer to 70% of their life expectancy beforeretirement. Consistent with other measures, Europeans fall in the bottom half of this measure. Overtime effective retirement age as a percent of life expectency is lowly correlated with future growth onits own (14%), and the measure has not had a meaningful relationship to future growth in the last 10years.

SAFMEXKORRUSINDARGTURPRTCHIJPNHUNUSAPLDPHPNZLVEZCZKSWENORIREGBRCHEAUSHKGCANDEUGRCNLDIDRESPITABRZBELFRAMALCHN

Effective Retirement Age as % of Life Expectancy

70% 75% 80% 85% 90% 95% 100% 105%

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Labor Market Rigidity

Support from the state to an individual can happen through either direct transfer payments and theprovision of government services (as we examined above), or by regulating companies to provideworkers with supports, e.g. enforcing a minimum wage or making it difficult to fire individuals. Unionscan also work to protect certain workers at the expense of others. To the extent that these structurallabor market supports limit companies from engaging with employees in a free manner, it limits theneed for individual self-reliance. And this approach limits the dynamism of corporations andindividuals to respond to conditions – which through time should make countries with high rates oflabor rigidity grow more slowly. Empirically our indicator through time does not have a strongrelationship with future growth but our data set here is most limited and what we care about most iswhether our logic makes sense.

Unionization rates is one of the measures where we see little relationship between the income of acountry and where it ranks. Still the measure shows different choices within countries of similarincome and it’s relationship to self-sufficiency makes sense to us. Unionization rates are low inFrance, the US, and Mexico (close to 15% and below). They are very high in Scandinavia, Italy,Russia and Argentina (35% and higher). This is one of the few measures on which China rankslower. Over time, this measure doesn’t have much correlation with future growth, 12%, and hasshown a similar low relationship in the last ten years.

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While we don’t have our other two measures of labor market rigidity (ease of hiring/firing andminimum wage as percent of average income) back through time, they have an intuitive relationshipwith self-sufficiency and show a picture today broadly consistent with our other measures. Lookingfirst at ease of hiring/firing, the US and Singapore rate as some of the most self-sufficient developedcountries, and among the most self-sufficient of any country on this measure. China is not far behind,still in the top quartile. Protections against firing appear to be high in Europe (both the core andperiphery but especially Spain and Portugal), which makes sense as structural reform is acontentious and important issue being debated now. Protections against firing also appear high inLatin America – Argentina, Brazil and Mexico are all in the lower half. The correlation of this indicatorand future growth in the past ten years was 28%.

SGPCHEHKGUSACANMALGBRTLDCHNHUNIDRBGLTURINDCOLTAIIRERUSNZLPERAUSCHIPHPPLDKORCZKNLDMEXGRCITAECDBRZBELDEUJPNNORARGFRAESPSWESAFPRTVEZ

Ease of Hiring and Firing Index

-2.50 -2.00 -1.50 -1.00 -0.50 0.00 0.50 1.00 1.50 2.00 2.50

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Turning last to minimum wage, we again see quite a bit of difference across countries even within thesame income group. Singapore is again at the top of the list, with the US not far behind. They arejoined by other developed countries, like France and Germany, and lower income ones like Mexicoand India. On the other end we see both developed countries, like Sweden and Italy, and lowerincome ones, like the Philippines and China, that have much higher minimum wages as percent ofincomes. Over the last ten years this indicator did not have much of a relationship with growth on itsown.

SGPRUSMEXFRAUSATLDNLDAUSCZKDEUINDBRZCHIHKGJPNPRTPLDHUNESPCANBGLNZLGBRKORGRCARGBELNORCHEIRETAIMALCHNPERIDRECDITACOLSWEVEZTURSAFPHP

Minimum Wage as % of Average Income

10% 20% 30% 40% 50% 60% 70%

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In Conclusion

Self-sufficiency matters. If self-sufficiency were the only thing that matters we would now create asimple formula that would allow you to plug in facts and that would provide you with an estimate ofwhat the next 10-years growth rate will be. That is useful to us. To the extent that policy makersagree with this formula, it could be useful to help them better set policy. To the extent that anyonedisagrees with the formula, we could examine the disagreements and see how they would improve orworsen it. However, since self-sufficiency is only one of the factors that matters, we will defer thatexercise until we show you the others and we can look at them all together.

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Other Countries

An Update on Developed World Labor MarketsFour years after the financial crisis, employment conditions in the developed world continue to beextremely weak. The level of unemployment is still near secular highs, wage growth has been atsecular lows, and employment growth has been anemic. This weakness in employment is creatingmediocre income growth which, coupled with the ongoing household deleveraging pressures,continues to add up to weak growth across the developed world. We think that this balance ofpressures is unlikely to create conditions that are sufficient to create a self-sustaining private sectorexpansion that materially lowers unemployment rates, and that developed economies will remainreliant on fiscal and/or monetary support. Current indications of employment conditions suggest to usthat this is still the basic dynamic. The pace of total employment growth is still below that of the laborforce growth, and wage growth isn’t moving from its secular lows. Businesses have been cuttingback investment in response to mediocre global conditions, which may also translate into a lowerwillingness to hire and/or increase wages. One positive is that total hours worked, which had beenflat during the slowdown earlier this year, is showing some signs of picking up in recent months. Butthe net of these pressures is that total income paid to workers is still flat. Looking across countries,the UK is showing stronger employment growth, but the numbers may still be a bit distorted by theOlympics and are not consistent with mediocre conditions across the broader economy. Employmentgrowth is weakening in Germany and Australia (which have had some of the healthier labor marketsover the past few years) and are modestly worse than the mediocre conditions in the US.Employment conditions in Europe’s periphery are still terrible. The modest bounce in developedworld demand in the wake of recent stimulation may still flow through to a modest improvement inlabor conditions. But that improvement will at best be a response to improvement in other parts of theeconomy, and one that may not be sustained. For now, labor conditions remain an ongoingweakness of most major developed economies.

Unemployment across the developed world in aggregate is still basically at its most elevated level inover 50 years. The recovery since the financial crisis has only managed to bring it down modestly,and over the past year, even that improvement has stopped.

While employment conditions are depressed to some degree across the whole developed world, theyare not homogeneous, and there are big divergences both in the degree of slack in different

Developed World Unemployment Rate

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countries’ labor markets as well as in their recent trajectories. The first chart below shows the broaddifferences in the level of employment across countries. The weakness is most extreme in theEuropean periphery (exemplified by Spain) where employment is more than 12% below 2008 levels(and is still declining) and strongest in Australia, Germany, and Canada. German employment hasbeen strong in part because Germany’s households have not had to deleverage in recent years andbecause German firms have benefited from their strong exposure to the emerging world and eurodeclines over the period. The increases in Australian employment (as we’ve described in priorObservations) have over the past several years come almost entirely from the strength of itscommodity production.

The unemployment rate also gives a sense of the level of employment conditions in each country in away that accounts for differences in labor force growth, but (as is particularly true in the case ofJapan) can be distorted by the regulatory environment in a way that makes cross-country comparisonless meaningful. What jumps out are the extremes in Europe: the change in the unemployment ratesince 2008 in Spain clearly suggests extreme weakness, while German unemployment has actuallyimproved from where it was before the financial crisis. Unemployment rates in the UK and US remainhigh, though no longer at historical extremes.

Developed World Employment

Dec 2007

Unemployment Rate (change relative to 2008)

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The trajectory of current conditions tells a different story. The UK, on the back of stimulation from theOlympics and strong BoE printing has recently been seeing the strongest employment growth in thedeveloped world. However, beneath that headline growth number, much of the employment growthhas come from part-time employees, and the discrepancy with weaker growth across the broadereconomy makes us question how sustainable that growth is. The European periphery is still seeingthe strongest contraction in employment conditions (although very recent numbers suggest thatemployment there is stabilizing). Labor markets in Canada and the US have been stronger of late,while the pace of employment growth in Germany and Australia has been slowing. Conditions inJapan are weak both in level and growth terms, and employment there is still contracting.

Hours worked provides another view on the trend in employment conditions that can better capturethe shorter-term move in conditions (as it’s easier for firms to shift hours than to hire and fire). Basedon this measure, the improvement in the UK looks less strong relative to that in the US and Canada.Germany and Australia suggest modestly weaker conditions that are contracting. Spain’s recentweakness is even more extreme on this measure.

Employment Growth (last six months, ann)

Total Hours Worked (Change over past six months)

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Stepping back and looking again at the developed world as a whole, the excess capacity indeveloped world labor markets is keeping wage pressures low. Wage growth has been steadilydeclining since the financial crisis, and is now also at secularly low levels.

Employment growth is much weaker than in a typical expansion and still barely keeping up withgrowth in the labor force, meaning that it’s insufficient to bring down the unemployment rate.

Hours worked is a somewhat more responsive measure of employment changes, because it’s easierfor firms to adjust the hours of those already employed than to hire or fire new employees. Earlier inthe period when the global economy was stalling, hours worked was basically not growing at all. Inthe past few months, there were some signs that they’ve been picking up. However in the currentenvironment, we wouldn’t expect businesses to increase their pace of hiring that much. Hiringdecisions are ultimately a response to a firm’s forward view of the economic conditions, and as we’vediscussed in prior Observations, recent statements from major firms suggest that they are gettingmore pessimistic about conditions.

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One corroboration of the above comes from looking at business decisions to engage in capitalinvestment. Business decisions to hire or fire are highly correlated to decisions to invest, and thechart below shows this relationship in the US. The rate of investment has come down pretty sharplyof late and now implies a somewhat slower pace of employment growth. Differences in the types ofcompanies that do a lot of capex and those that hire a lot of people mean that this comparison cannotbe taken too far, but it’s a data point that speaks to the pessimism in the current business climate.

The combination of weak employment growth and weak wages means that total employeecompensation growth is also weak. Growing stably at about 3%, it’s well below the pace of the lastexpansion. In a credit-constrained environment, the money that goes to workers is the money theyhave to spend. As long as worker incomes grow at this mediocre pace, this will be an ongoing dragon conditions.

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22Bridgewater® Daily Observations 10/31/12

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