U.S. productivity slows to a standstill

/ Source: The Associated Press

Growth in productivity — the key ingredient for rising living standards — skidded to a standstill in the late summer while workers’ wages and benefits shot up at the fastest clip in more than two decades.

The combination of slowing productivity and rising wages was seen as a formula for inflation troubles down the road. It could keep the Federal Reserve from cutting interest rates any time soon and possibly lead to another increase.

Productivity, the amount of output per hour of work, showed no growth at all from July through September. Growth was just 1.3 percent over the past 12 months, the weakest showing in nine years.

The cost of wages and benefits measured by each unit of output grew at an annual rate of 3.8 percent in the third quarter.

Employee compensation climbed by 5.3 percent over the past year. That gain was the fastest since a 5.8 percent rise in the 12 months ending in the fourth quarter of 1982.

Both the extent of the weakness in productivity and the size of the increase in unit labor costs caught analysts by surprise. They said the numbers were certain to raise concerns at the Fed about future inflation risks.

Higher wages and benefits are good news for workers. But such increases can trigger inflation if companies pass on the higher wage costs by making products more expensive.

Rising productivity allows companies to pay their workers more from the increased production rather than having to finance the wage increases through price increases.

“If rising unit labor costs are passed on in higher prices, that would mean stubbornly high inflation and no rate cuts from the Fed,” said Nigel Gault, a senior economist at Global Insight.

Companies could pay the higher salaries from their profit margins, which have jumped in recent years, but that would mean less in returns for shareholders.

Wall Street had hoped the slowing economy would translate into Fed rate cuts. It reacted negatively to the productivity report and news of a mixed sales performance in October at major retailers. Many shoppers apparently took a breather last month after a shopping spree in September.

Wal-Mart Stores Inc. reported a meager 0.5 percent rise in same-store sales in October. The company said it would trim prices to gain market-share in such areas as toys and electronics. Consumers would benefit during the holiday shopping season but the move could mean lower profit margins as other stores struggle to compete.

In other economic news, orders to U.S. factories for manufactured goods rose by 2.1 percent in September. While that was the biggest increase in six months, it was heavily influenced by a huge surge in demand for commercial aircraft. Outside of transportation products, factory orders actually fell by 2.4 percent.

The Fed raised interest rates 17 consecutive times through June of this year in an effort to slow the economy enough to bring inflation pressures under control. The Fed has left rates unchanged for three straight meetings, hoping it has done enough to brake economic growth.

But the significant slowing in productivity growth and the continued rise in wage pressures could prompt the Fed to resume raising interest rates to fight inflation, analysts said. At the very least, it will mean a prolonged period before the Fed feels safe in cutting rates.

“The Fed will not be easing anytime soon unless the economy absolutely falls apart,” said Stephen Stanley, chief economist at RBS Greenwich Capital.

Since 1995, the U.S. has enjoyed a decade of strong gains in productivity. But as the economy has slowed this year, productivity has slowed, too, even as unit labor costs have risen by rates of 3 percent or more in each of the past five quarters.

The 1.3 percent rise in productivity over the past four quarters ending in September represented a significant slowdown compared with rates averaging more than 3 percent annually from 2002 through 2005.

“Productivity is not growing fast enough to keep labor costs from pressuring firms,” said Joel Naroff, chief economist at Naroff Economic Advisors. “The labor cost numbers raise concerns that it may take quite a long time for inflation to settle down and decline significantly.”