2011: The most new jobs since '95?

Early in 2010, the U.S. economy seemed to be on the sure path to recovery. Nearly a million jobs were created from March through May. Stocks, which entered the year on a tear, soared to new highs in April. Gross domestic product growth averaged 4.4% in the six months to March. All was right in the world.
Simply put, we hit a string of icebergs. The European debt crisis. The Deepwater Horizon oil spill. The government's case against Goldman Sachs which put the financial world on edge. Now the economy is again struggling to stay afloat. Some 55,000 jobs have been lost in the last six months. The unemployment rate just jumped to 9.8%.
The housing market remains moribund. Consumer confidence has stalled. Federal Reserve chairman Ben Bernanke has even warned that the economic growth rate may not be self-sustaining.

All of this makes the question even more critical: What will we see in 2011?

As we close in on the new year, the situation remains fragile. But new evidence suggests the recovery, now more than a year and a half old, not only is still on, but is picking up speed again.

The index of leading economic indicators, maintained by the Conference Board, has reaccelerated -- a sign the economy is regaining its vigor. The Europeans have bailed out Greece and Ireland and nationalized troubled banks. They have also been forced to prop up their government debt market. The Fed isprinting a fresh $600 billion to inject into the financial system -- adding to the $1.7 trillion it has already spent.

President Barack Obama has apparently struck a deal with Republicans in Congress to extend emergency unemployment benefits along with the Bush tax cuts.

Now consumer spending is poised to replace inventory restocking and government stimulus as the main driver of economic growth. And that means that the biggest job gains in years, along with stock market advances and higher home prices, should be just around the corner.

Here's why:

The jobs squeeze

While it's hard to believe, the economy is growing. In fact, it's been growing for more than five consecutive quarters. But all the benefits seem to have been funneled to denizens of corporate suites and Wall Street trading floors instead of the average Joe.

While corporate profitability has soared to record highs, fewer and fewer people are participating in the work force. This has padded profit margins and boosted share prices. Because of the scarcity of jobs, the employment-to-population ratio has fallen to levels not seen since 1983.

At the same time, to simply survive, households have become increasingly reliant on government transfer payments -- such as unemployment benefits and Social Security checks. According to Bank of America Merrill Lynch calculations, these transfers account for more than 9% of overall personal income, up from less than 2% in 2007.

Because of this, productivity, defined as output per worker, has surged at a rate not seen since the 1960s as companies have squeezed more and more out of their staffs. Those with a job don't complain for fear of joining the army of the unemployed. New hiring hasn't been necessary.

But this is changing now. Productivity is beginning to fall. And with economic activity continuing to increase, companies have to turn to alternatives.

There was a surge of temporary hiring in November, the largest since January, in what is a precursor to permanent job creation. And the average workweek increased at a 1.1% annual rate in the third quarter, the fastest rate in 25 years, as existing employees worked longer hours. It can't increase much more: The average length of the workweek from 2001 to 2007 was 33.8 hours, just three-tenths of an hour above the current level.

The next step, according to Deutsche Bank economist Carl Riccadonna, is clear: "(E)mployers have stretched the workweek for existing workers pretty much to its limit and now must add additional employees in order to further expand output."

2.5 million new jobs -- or maybe even 3.9 million

So, how many new jobs are we talking here?

Assuming productivity slows to levels consistent with the last four recoveries, Riccadonna estimates the economy will create 2.5 million new jobs in the New Year. Under a more optimistic scenario, in which productivity growth falls to zero, as it did most recently in the 1970s and 1980s, he suggests the economy could create as many as 3.9 million new jobs by the end of 2011.

To put that in perspective, through November the economy had created just 950,000 jobs in 2010. The last time 3.9 million or more jobs were created in a 12-month span was in 1995. For 2.5 million jobs, it was 2006.

That addition of 3.9 million jobs would be enough to push the unemployment rate down to 7.3% -- which is close to the economy's "natural" unemployment rate. This concept was the subject of one of my recent columns and formedpart of my criticism of the Fed's $600 billion money-pumping initiative announced in November.

Yes, the most recent jobs report was terrible: Just 39,000 jobs were created last month, compared with 172,000 in October. The 50,000 private sector jobs that were created was the worst showing since January. Hourly earnings were flat. And the retail sector, which carried high hopes heading into the holiday shopping season, lost 28,000 jobs.

Yet there is plenty of evidence to suggest an improvement in the labor market is already under way.