Commentary: The Power Of Productivity: Why This Recovery Will Roll On
From the beginning, this economic recovery has felt different. Officially, it began back in November, 2001. But it has only been in the past few months that growth has been strong enough for Corporate America to hang out the "For Hire" signs and take on more workers. And now, just as the job market has turned up, fears are mounting in financial markets that an inflationary brew of rising interest rates and surging oil prices will prematurely cut short the growth and the upswing in hiring.
It doesn't have to be that way. Indeed, such fears are probably misplaced. That's because the elongated start of the recovery means that the economy probably has a lot more room to run before it encounters a dangerous spurt in inflation. The key is productivity growth. It has been running at a remarkable 4.6% annual rate since the end of the recession and is the main reason the recovery has been so unusual.
It's not just that strong productivity gains allowed companies to put off the need to begin hiring. They have also helped to contain inflation by holding down labor costs, businesses' biggest expense. And they enable companies to do more with less, easing the strain on the economy as the expansion matures. "Strong productivity growth augurs well for a long and fairly strong expansion," says former White House Chief Economist Martin N. Baily.
In fact, the economy appears to have entered a sweet spot in which rising corporate profits and increasing personal incomes should play off each other in a virtuous cycle of expanding activity. In the early stage of the recovery, when demand was sluggish, the benefits of productivity went largely to businesses, which saved money by cutting jobs. But now that the jobs market has finally turned up, workers have begun to share in the gains, which should make the recovery more sustainable. Because companies are getting more out of their workers, they can afford to pay them a bit more while still enjoying powerful profits.
To be sure, productivity growth is likely to slow somewhat as new hires adjust to their jobs. That process may have already begun in the first quarter, when productivity growth ebbed slightly to a 3.5% annual rate. But that's still well above the 1.5% pace that prevailed in the two decades before the mid-'90s boom. Indeed, productivity's recent performance has prompted experts to bump up their estimates of its long-term trend rate, to 2.5% to 3%. Factoring in labor-force growth of about 1% per year, U.S. annual gross domestic product can grow by 3.5% or better over the long run without worrying about overheating.
Of course, the economy has been expanding a lot faster than that of late, growing an average of 5.5% over the last three quarters. That and an uptick in inflation are fanning fears in financial markets that the economy no longer enjoys much running room. The big worry: the Federal Reserve will have to jack up interest rates sharply to keep inflation in check, damaging the economy in the process.
But the stretched-out start to the recovery has left Fed Chairman Alan Greenspan and his colleagues with enough leeway to take a more leisurely approach to raising rates. Courtesy of strong productivity growth, inflation is still low 31 months into the recovery. Although it is up a bit recently, the Fed's preferred measure of inflation -- the personal consumption expenditure price index, excluding food and energy costs -- was a mere 1.4% higher in March than a year ago, well within the 1%-to-2% comfort range of many central bankers.
What's more, the slow pace of job creation at the start of recovery means that there's still slack in the labor market, even after the recent outsize gains in payrolls. That reduces the risk that the economy will fall into a dangerous wage-price inflationary cycle.
Sure, the jobless rate has fallen from a high of 6.3% last June to 5.6%. But much of that represents discouraged workers leaving the workforce. If labor-force participation were at the level it averaged in the '90s, unemployment would be over 7%, says International Strategy & Investment Group Inc., an institutional broker. With the labor market that slack, there's no reason for companies to get into bidding wars for workers.
At some point, of course, the economy will bump up against its limits and start to overheat. That happens in every cycle; this one won't be any different. But enduring productivity growth should keep that day quite a ways off still.
By Rich Miller and Peter Coy