Relax. That Productivity Dip Was Just A Blipby
With inflation-hunting season in full swing, vigilantes are scouring the economic underbrush for signs of the pesky varmint. Slow growth in labor costs and even slower growth in the economy offer no rustling in the leaves. But evidence that productivity dipped in the second quarter certainly means the hunters won't be stowing their firearms any time soon.
What's the danger? A drop in productivity means that the cost of producing each unit of output increased, perhaps sharply, in the past quarter. Moreover, in the long run, higher productivity is the only way in which businesses can raise the real wages of their workers without increasing their prices at the same pace.
What seems to have happened in the spring, however, is that businesses, chiefly services, overhired. Job growth hit its fastest pace in seven years. But because final demand was something of a disappointment last quarter, output per hour worked very likely fell--perhaps at a 2% annual rate or more. And that suggests that unit labor costs may have jumped by as much as 5%.
Bear in mind, though, that the second-quarter performance was a temporary slip rather than a new trend. The cyclical gains in efficiency are falling away--even as the long-term, technology-driven improvement in productivity remains in place. Indeed, even with a big decline last quarter, productivity would still be an impressive 2.2% higher than it was a year ago.
That may not placate the inflation hawks when the Labor Dept. issues its productivity report on Aug. 9. The stumble is apt to touch off a shotgun volley of calls for tighter monetary policy at a time when Fed Chairman Alan Greenspan himself seems itchy to pull the trigger.
The productivity drop was widespread. Factories, which have strung together 12 quarters of efficiency gains, struggled to stay in the plus column last quarter. Hours worked grew faster than manufacturing output, suggesting no gain in productivity (chart). But that still means a 4.3% advance from year-earlier readings. And the annual pace of factory unit labor costs would still be falling.
Services, however, probably lost much more ground. If factories' productivity was stuck in neutral, services' output per hour worked dropped sharply. Not surprisingly then, the service companies are having a harder time lowering their unit labor costs, especially since the growth in averall compensation in services may have hit bottom (chart). As companies struggle to lower their labor bill, job growth in services may begin to taper off in the second half.
But despite the cyclical slowing in productivity gains, the news for unit labor costs--and thus inflation--isn't all bad. That much is clear from the Labor Dept.'s employment cost index.
The ECI for all civilian workers in the second quarter rose 0.9% from the first quarter, and it was up only 3.2% from a year ago. That was the smallest annual increase since the government began keeping such records in 1981, and it's a sign that labor costs will not be pushing up inflation in the coming months.
Union pay growth is faring worse than nonunion gains. Wage increases in the major collective-bargaining agreements reached in the second quarter, which cover some 627,000 workers, averaged 2.4% annually. That's lower than the 3% gain in the contracts that were replaced.
Although wages and salaries together make up about three-fourths of total labor costs, it's the moderating trend in benefits that accounts for the continued slowing in employment costs. In the private sector, wages last quarter showed a 3.1% increase from a year ago, a slight pickup from 2.7% in the second quarter of 1993.
But over the same period, the annual growth of benefit costs dropped from 5.8% to 3.9%--and that's down from a 7% clip four years ago. Benefit costs are growing more slowly because of continuing moderation in the pace of employers' insurance costs for health coverage, workers' compensation, and state unemployment programs.
Comparing labor costs for goods producers with those for service companies, however, reveals another reason why services face tough going in trying to hold their unit costs in check: Although wages and benefits for goods producers continue to slow, compensation growth in services has stopped declining. Looking ahead, unit labor costs in services will start growing faster--if there are no productivity gains. And higher costs will put pressure on payrolls at any company that cannot raise prices.
The prospect of slower job growth is one reason consumers are a shade less euphoric about the economy these days. The Conference Board's index of consumer confidence slipped to 91.6 in July, down from 92.5 in June. Still, the index remains near its high for this expansion, suggesting consumers may rein in their spending increases, but they won't cave in.
Consumers' confidence about their present economic situation has been in a solid uptrend for a year now, hitting 92.6 last month (chart). And while their expectations about the future slipped to 90.9 in July, down from 94.6 in June, the index is still at a high level.
The Conference Board reported that jobs remained an important concern for many consumers and that persons worried about employment prospects continued to outnumber those who considered jobs to be "plentiful." The Board also noted that the leveling off in the expectations component "suggests a continuation of steady, moderate economic growth in the second half of the year."
The temperate trend is echoed by some of the other latest data. Sales of existing homes fell for the second month, slipping 3.6% in June, to 3.96 million. And jobless claims remain unusually high, given the pickup in hiring. New claims rose to 392,000 in the week of July 16, after 363,000 were filed in the previous week--when state offices took a day off for the Fourth of July. Also, the Johnson Redbook Report said that sales in the third week of July were down from June.
Even Washington will be a drag on the economy. With a $15.2 billion surplus in June, the federal budget deficit so far this fiscal year is running 25% below its pace of last year. And since receipts are growing much faster than outlays, the red-ink total for fiscal 1994, which ends in September, could come in below $200 billion--to as low as $190 billion--for the first time since fiscal 1989.
One area still showing some pep is the durable-goods sector of manufacturing. New orders there rose 1.3% in June, the fourth consecutive gain (chart). Demand for nondefense capital goods bounced back by a strong 6.2%, after falling for four straight months.
The new demand coming on-line means that manufacturers are beginning to rebuild their backlog of unfilled orders--if only by tiny increments. Unfilled orders rose 0.2% in June, the third small increase in a row.
The backlog is down from last June, though, and inventories overall in the economy ended the second quarter at high levels. That means output growth will likely slow again this quarter--even as businesses continue the long process of installing high-tech equipment and rejiggering production practices that raises their productivity permanently.
Indeed, it is important to remember that productivity does not move in a straight line. Setbacks, as in the second quarter, will happen, but they don't derail the longer-term improvement in efficiency now taking hold. As companies take up the gauntlet of global competition, their smarter use of computers, management skills, and technology is creating a more productive--and less inflationary--economy.