The Return of Two Recession Fighters
Productivity and globalization were key economic themes around the turn of the 21st century. They supported U.S. growth through the 2001 recession, helping to make it the mildest downturn on record, and they exerted a powerful force against inflation. Well, this dynamic duo is back. Although circumstances are far different this time, the two are once again providing help to an economy in trouble. They may not ultimately prevent a recession, but they've been doing a pretty good job of it.
That's especially true on the global front. The dollar's decline has put U.S. exporters in a highly competitive position to gain from expanding overseas opportunities, while helping to stem the import tide. The shrinking trade deficit, after adjusting for inflation, is a plus for economic growth, and it has been a major contributor to keeping the U.S. economy afloat. Without the one-percentage-point addition to growth in gross domestic product in the fourth quarter, real GDP would have fallen 0.4% instead of rising 0.6%.
Moreover, the unexpectedly large drop in the U.S. trade deficit, to $58.2 billion in March from $61.7 billion in February, was greater than what the government had factored into its 0.6% estimate of first-quarter GDP. Partly reflecting the strong trade data, economists expect first-quarter growth figures to be revised higher. Trade support will continue this year. U.S. exports are likely to slow as global growth cools, but U.S. imports will also weaken amid softer U.S. demand.
Compared with the benefit the economy gets from foreign trade, the surprisingly strong performance of productivity is less obvious but no less important. Productivity growth, which typically slows in sync with the economy, has actually accelerated in recent quarters. Measured as output per hour worked, it posted a solid 2.2% gain in the first quarter, and an upward revision to GDP will push the gain even higher. Although economic growth has averaged only 0.6% for the past two quarters, productivity gains have averaged 2%. That's faster than the pace in the previous two years, when the economy was much stronger.
Business' recent efforts to achieve better productivity gains, mainly via cutbacks in hours worked, are one reason profits are holding up better than expected. Another is the boom in earnings from overseas operations. With almost 90% of the companies in the Standard & Poor's 500-stock index having reported for the first quarter, earnings are on track to drop 17.4%, according to Thomson Reuters (TRIN). However, excluding the 79% plunge in finance, earnings in all other sectors are up 7.1%. Even excluding the hefty contribution from energy, profits are still up 2.8%. The earnings performance so far is hardly typical of the broad declines seen in a recession.
Why? Over the past year businesses have cranked up their output per hour while ratcheting down the growth in hourly pay. That combination has resulted in a sharp slowdown in labor cost per unit of output. In fact, prices in the private nonfarm sector, which are up 1.5%, have risen faster than the 0.2% gain in unit labor costs. That gap suggests unit profits, or margins, are holding up far better than they did in the 2001 recession.
Success in holding down labor costs is also a big plus in the inflation outlook. Although prices of oil and other commodities are soaring, labor is by far the biggest cost of production and the crucial factor in containing expectations of future inflation. Rising unit labor costs often impel businesses to attempt price hikes to cover the added cost, but with wage growth slowing, the classic inflation spiral in which wages and prices drive each other higher can't get started.
Indeed, the April report on consumer prices shows inflation outside of energy and food has slowed sharply over the past three months. Meanwhile, other data continue to suggest either a mild recession or no downturn at all. It seems the trends in productivity and global trade, once again, may have a lot to do with how the current business cycle plays out.