How can the economy have grown at an annual rate of 2.8% so far this year without any increase in private-sector employment? The answer is productivity. Corporations are squeezing more output from each hour that employees work. That's usually the case in a recovery, but this time, the efficiency gains could lead to noninflationary growth for years to come.
The much-hoped-for productivity revival following the recessions of the early 1980s faded as the recovery picked up steam. One reason was demographics: More younger and less-skilled workers entered the job market. More important, the debt explosion inflated economic growth and pumped up payrolls, particularly in the service sector. The upturn in productivity growth early in that recovery turned out to be just a flash in the pan.
This time could be different. Unlike the past decade, the work force is now older and more experienced. Also, demand is now running on more traditional fuel, such as household purchasing power and corporate cash flow. Compared with the roaring '80s, the slower pace of demand is causing payrolls to look fat, and many companies are making permanent payroll cuts to increase efficiency and competitiveness.
The gains so far this year have been impressive. The Labor Dept. recently revised the third-quarter advance in productivity up to 3% from 2.6% originally. Even modest growth this quarter assures that output per hour in 1992 will rise at the fastest pace since 1975.
Efforts to boost efficiency explain the sluggishness in job growth, a stark contrast to the buoyant pace in past recoveries (chart). Nonfarm industries added 105,000 workers to their payrolls in November, but that included 45,000 temporary election workers in local governments. Excluding all government, private-sector jobs rose by only 45,000 last month, and the trend remains flat.
CAPITAL SPENDING SURGES AHEAD
But companies aren't just eliminating jobs. They are also investing heavily in productivity-enhancing equipment, especially computers and other information processors. So far this year, capital spending on equipment has risen at an annual rate of 11.8%--the fastest three-quarter pace in eight years. And spending on information-processing equipment has soared at a 21.8% pace.
The combination of rising investment in equipment and leaner payrolls heightens the chances for a lasting upswing in productivity growth. The numbers suggest that companies are making long-term substitutions of capital for labor. That makes sense. Now, as in no other time in past decades, very low interest rates are making capital look increasingly cheap relative to labor, particularly as the cost of employee benefits continues to soar.
If productivity is indeed shifting to a higher plane over the long haul, improved efficiency will hold down the growth of unit labor costs, a key determinant of inflation. During the past year, unit costs have risen at the second slowest pace in 27 years. In that environment, wages can grow a bit faster without pressuring prices, thus lifting the purchasing power of hourly pay. Slowly rising unit labor costs also mean that profit margins can widen even if pricing power remains weak.
HOUSEHOLD INCOMES ARE PICKING UP
Right now, because efforts to boost productivity are retarding job growth, the workweek may be a better indicator than jobs of how the economy is doing. Despite lackluster employment growth, hours worked have risen during the past two months, in line with the better tone of much of the other economic data recently.
In November, the workweek in nonfarm industries rose to 34.7 hours, following an increase to 34.5 hours in October from 34.3 hours in September. The November reading was the highest in more than three years.
So far in the fourth quarter, total work time--a combination of employment and the workweek--has grown at an annual rate of about 3% above the third-quarter level. That suggests that real gross domestic product is likely to post a good advance this quarter. And with a pickup in hourly pay, household incomes are rising, despite weak job growth.
In particular, manufacturing appears to be gaining some momentum. Factories stretched out their workweeks in November, to 41.3 hours, up from 41.1 hours in October and 40.9 hours in September (chart). The November level matched the 26-year high hit earlier this year. Moreover, factories added 35,000 workers in November, the largest increase in nearly three years. The long workweek, combined with bigger payrolls, means that industrial production probably posted a strong advance last month.
One of the the most telling features of the November job data was the scant 21,000 gain in employment among private-sector service companies. The biggest loser was retailing. It did not add as many workers this year as is typical at this time of year, so seasonally adjusted employment dropped by 46,000. Service companies, which account for three out of every four jobs, were the biggest hirers during the 1980s. Now, they are striving to increase their efficiency.
MORE CASH, LESS CREDIT
In addition to the longer workweek, another upbeat message from the employment report, particularly for consumers, was the pickup in wage growth. In fact, after a long slide, the pace of hourly pay may well have hit bottom (chart). True, the speedup is faint. But wage gains have been falling for nearly four years, so workers are especially encouraged by any increase in pay.
The average nonfarm wage rose 0.6% in November, to $10.71 per hour. After smoothing out monthly fluctuations, wage growth has picked up to 2.5% over the past year, slightly better than the 2.3% posted in the summer.
That pickup, plus the longer workweek, means workers are taking home fatter paychecks. Weekly pay for all nonfarm workers jumped 1.1% in November, on top of a 0.8% gain in October. The November number suggests that the wage-and-salary component of personal income posted a healthy increase last month.
But the recent rise in wages does not signal any resurgence in inflation. Even if wages continue to pick up, productivity increases will keep unit labor costs on a downward track. Unit labor costs for nonfarm businesses were up by just 0.5% over the past year--quite a tumble from their 5.9% pace of a year ago.
What the wage increase does signal, however, is that households have the wherewithal to finance their holiday shopping. The first few weeks of the season seem to have gone well. Johnson Redbook Service, published by brokerage Lynch, Jones & Ryan Inc., reports that store sales during the first week of December were up by a sturdy 6.9% from last year's receipts.
In addition to the rise in income growth, consumer spending both now and in 1993 will get an additional lift from the reduction of household debt obligations. Consumer installment credit grew by a tiny $214 million in October, only the third time this year that consumers added more debt than they paid off. And credit outstanding remains below its level of a year ago, a pattern that began in mid-1991.
This shrinkage means that debt is less of a drag on consumers. Installment credit as a percent of aftertax income slipped to 16.1% in October, the lowest such ratio since 1985 (chart). A smaller debt load means that households need less of their budgets to pay off old IOUs, and that leaves more cash for spending. However, consumers will maintain their buying pace only if they feel the recent pickup in jobs is sustainable and not just a fluke.
The November job report suggests that the demand for labor is indeed turning the corner. For the near term, economic growth in 1993 promises to be better balanced between gains in efficiency and additions to payrolls. And over the long haul, the economy may well be poised for a best-of-all-worlds scenario: moderate growth, subdued inflation, and low interest rates.