Last week, the Labor Department released its preliminary report on 4th quarter productivity. The good news is that after two quarters of stagnant growth, workers’ output per-hour grew at solid 3 percent pace during the last three months of the year. Also noteworthy is the fact that real (inflation-adjusted) hourly compensation rose by a very strong 7.1 percent in the fourth quarter. This should dispel the myth that workers are not benefiting from the economic expansion.
In fact, for the year overall, real workers’ hourly compensation grew a robust 2.1 percent. This is the fastest pace since 2000 and equal to overall 2.1 percent rise in productivity growth last year. Some have claimed that workers have not benefited from the rise in productivity during the current expansion. However, last week’s report dispels this claim. The fact is that workers are now benefiting from a tight labor market that this expansion has produced. It should be pointed out that workers’ real incomes did not start to post significant increases during the 1990s until the unemployment rate fell below 5 percent. What we are seeing today is history repeating itself — a growing economy producing a tight labor market starts to put upward pressure on compensation.
For manufacturing, productivity increased by a strong 3.9 percent in 2006, slightly faster than the 3.7 percent rise in output (this marks the 3rd consecutive year that manufacturing outpaced the overall economy). The fact that manufacturing productivity slightly outpaced output in 2006 helps explain why manufacturing employment edged down last year.
However, the report did contain some warnings as well. Productivity growth is moderating. The 2.1 percent rise last year was the fourth consecutive deceleration and the slowest pace in nearly a decade. This, combined with a 5.3 percent in nominal hourly compensation, resulted in unit labor costs (equal to hourly compensation minus productivity growth) advancing by 3.2 percent in 2006 — this is the fastest pace in 6 years! And, since unit labor costs is the underpinning for overall inflation, it appears that inflationary pressures will likely be a growing concern for the Federal Reserve in 2007. Whether or not the Fed will increase interest rates will likely be driven by how fast the economy continues to grow. Our outlook calls for the economy to cool a bit this year. If this occurs, the the Fed will likely maintain a holding pattern.
Looking to the week ahead, government reports on international trade (Tuesday), retail sales (Wednesday), industrial production (Thursday) and housing (Friday) should give some indication if, in fact, the economy is starting to cool off a bit.
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