U.S. Productivity
Advances 6.3 Percent
Good News for Inflation, Interest Rates
and Stocks
Today, the Department of Labor
reported productivity in the nonfarm
private business sector increased at a
6.3 percent annual rate in the third
quarter of 2007. This was significantly
higher than the 2.2 percent increase
recorded in the second quarter.
Since the third quarter of 2006,
productivity has advanced 5.8 percent,
and this is a good solid performance.
Continued strong productivity growth
helps keep inflation in check in the
face of rising oil prices, and
accommodates moderate wage growth.
Credit markets are stuck, and the Fed
needs to make bold moves—bolder moves
than talked about. Robust increases in
productivity give it what it needs to act
decisively.
Labor Costs, Inflation and the
Stock Market
Hourly compensation increased 4.2
percent annual rate in the third
quarter, and unit labor costs, which
factor together higher wages and
productivity, fell 2.0 percent. Strong
productivity growth permitted decent
wage increases, and these pose no
significant threat to accelerate
inflation. Thanks to rising
productivity, wage pressures should not
constrain Federal Reserve interest rate
setting policy.
Prospects for inflation remain mostly
determined by foreign oil prices, and
cost pressures in China’s manufacturing,
which supplies a significant share of
U.S. consumer goods. A significant
revaluation of the yuan against the
dollar would reduce pressures both on
global oil supplies and wages in Chinese
manufacturing, and do much to constrain
global inflation.
At its December interest rate setting
meeting, the Federal Reserve will weigh
the impact of the subprime crisis on the
housing market and consumer spending.
Market expectations point to a cut in
the Federal Funds rate by at least a
quarter point to 4.25 from the current
4.50 percent. A cut to 4.0 seems more
likely.
Productivity growth fuels corporate
profits by permitting U.S. businesses to
maintain or widen margins on domestic
operations. Also, U.S. businesses are
taking their innovations abroad, and
foreign operations account for
significant shares of U.S. corporate
sales and profits.
Better Productivity Growth Ahead?
U.S. companies continue to bang out
new products and more efficient methods
for making goods and services. In the
third quarter, manufacturing
productivity was up 5.0 percent. In the
critical durable goods sector, which
builds out many of the breakthroughs in
information technology, productivity was
up 6.1 percent.
These trends indicate U.S. durable
goods manufacturers and technology-based
services should be gaining global market
share. But for the China’s undervalued
yuan, U.S. durable goods manufacturers
would not be losing market share and
jobs to Asian competitors, and but for
arbitrary restrictions on U.S.
investment, the presence of U.S.
services providers in China should be
larger.
Productivity should continue to
advance, and looking beyond the
adjustments associated with the subprime
crisis, the growth potential for the
U.S. economy remains formidable.
Factoring in a one percent annual
increase in the labor force, the economy
could grow 3.5 to 4 percent a year with
the right mix of fiscal, monetary and
exchange rate policies.
The overvalued dollar against the
Chinese yuan, Japanese yen and other
Asian currencies limits productivity
gains, because the resulting trade
deficit shifts labor and capital from
export and import-competing industries
into other non-trade-competing
activities. Trade-competing industries
exhibit 50 percent higher labor
productivity and spend much more on R&D
than do the rest of the economy.
Also, the trade deficit shifts the
production of new and innovative
products offshore, reducing high-value
employment immediately and increasing
the likelihood that next generation
products will be developed, as well as
made, abroad.
Cutting the trade deficit in half
would boost R&D spending enough to push
sustainable productivity growth to about
3 percent per year, and raise potential
GDP growth to about 4 percent.
Peter Morici is a professor at the
University of Maryland School of
Business and former Chief Economist at
the U.S. International Trade Commission. ►More Faculty
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