More Jobs—But at What Cost?

Coupled with rising pay and flat productivity, the five-year low in unemployment raises concerns about interest rates, corporate profits, and inflation

by Peter Coy

Three years ago, people were justifiably complaining about a jobless or even "job-loss" recovery. The expansion of payrolls after the 2001 recession was agonizingly slow. The problem was that although output was expanding, workers were getting much more productive. Because each worker was doing more, the workforce didn't need to grow. Eventually, of course, job growth perked up.

Now we're in almost the opposite situation, as seen in two reports this week from the Bureau of Labor Statistics. Job growth is reasonably strong, pay is rising, and productivity growth is nonexistent, according to the BLS. More Americans are finding work and at higher pay, but this situation is less sustainable over the long run than the previous one. This means the economy is at some risk of falling corporate profits, rising inflation, and a runup in interest rates that could doom the economic expansion.

On Nov. 3, the BLS announced that according to its employer survey, nonfarm payrolls increased in October by 96,000. While that number was a bit below expectations, the government revised upward by 139,000 its estimates of total job growth over the previous two months. And it said that according to its household survey—a parallel measure—the economy added a huge 437,000 jobs in October as the unemployment rate fell to a five-year low of 4.4%.

Less Productive Hires

That's healthy job growth. Trouble is, it comes at a time when the real output of the economy isn't increasing a whole lot. In the July-September quarter, output increased at an annual rate of just 1.6%. More workers, but not much more output is just as bad for the economy as a whole as it is in your own workplace.

On Nov. 2, the Bureau issued a worrisome report that worker productivity—that is, the output per hour of work in nonfarm businesses—did not increase at all in the third quarter. Productivity had increased 3% in 2004 and 2.3% in 2005. True, productivity measures fluctuate a lot and the trend rate is almost certainly better than zero. But the third-quarter number is still worrisome. Zero productivity growth is what you get when the economy has already put the most productive people to work and has to dig into the ranks of the less productive.

Merrill Lynch's (MER) Chief North American Economist David Rosenberg points out that the unemployment rate for college graduates is already under 2% and now the unemployment rate for nongraduates is coming down fast—from 7.1% in July to 5.8% in October. "All those pundits claiming that we were at the end of the rope as far as skilled labor availability was concerned are proving to be vindicated," he wrote.

The Fed Faces a Curveball

Rising pay for workers is a good thing when productivity is also rising, but it's not so healthy when productivity is flat. In the third quarter, the government said, unit labor costs rose at a seasonally adjusted annual rate of 3.8%. And in October, average hourly earnings rose a bigger-than-expected 0.4%. That's not good for inflation—or for corporate profits.

All this creates a tough situation for the nation's central bank. Ordinarily, the Federal Reserve might cut interest rates to stimulate growth at this stage. But the labor market is giving off inflationary signals, so Ben Bernanke and crew don't dare cut rates now. If anything, the Fed's next rate move might be a hike.

The bond market reacted badly to the jobs numbers on Nov. 3, with Treasury bond prices falling by the most since July, 2005. The yield on the 10-year note bounced backed up to over 4.7% after a late-October dip below 4.6%. (Rates rise when prices fall.) Stocks also fell, though less steeply. The Dow Jones industrial average fell 32 points to dip back under 12,000 and close at 11,986 on Nov. 3.

The optimistic spin is that the spurt of job growth in October shows that the economy has accelerated from its third-quarter lull. If so, that's great. One thing's for sure: This is no "job-loss" recovery. The question: Does today's job growth have a sound foundation?

Coy is BusinessWeek's Economics Editor.