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The Dark Side of the Productivity Surge

Rising productivity is usually one of the best things you can hope for in an economy. It means people are producing more for each hour they work. That's the path to higher living standards. But the huge burst in productivity that the U.S. economy experienced in the third quarter is not entirely good. In fact, it's a sign that the U.S. economy is still in a sickly condition—a conclusion that is likely to be driven home by the latest job-loss figures release on Nov. 6. Economists who cheered the productivity number are ignoring the dark side of its sudden growth. On Nov. 5, the Bureau of Labor Statistics announced that productivity—that is, output per hour of work—in the non-farm business sector grew at a 9.5% annual rate in the July-September quarter. That was one of the three biggest gains in the last 30 years, and it followed a strong annualized gain of 6.9% in the second quarter. What could be wrong with that? The problem is how the productivity growth was achieved. It wasn't because of clever efficiency measures or the purchase of wonderful tools that help people get their jobs done faster. Such improvements take years, not mere months. Rather, it was because companies cut jobs and work hours drastically. Worker MoraleWork hours fell at a 5% annual rate even as output increased at a 4% rate, the government said. So people working shorter hours had to do the same amount of work as before, or more. People who kept their jobs had to pick up the work of ex-colleagues. Many workers probably put in extra hours that weren't counted in the statistics in order to get all their work done. That would exaggerate the output-per-hour gain. Speedups are rarely good for worker morale. Recent surveys by firms such as Watson Wyatt and Spherion Staffing Solutions show that workers are increasingly fed up and are likely to bolt for other jobs as soon as the economy strengthens and hiring resumes. What's more, productivity that's achieved through slashing hours is a negative for the overall economy. Workers who are laid off or given reduced hours can't afford to spend as much money, so demand for consumer goods remains soft. Economists who welcomed the productivity numbers observed that they should be good for corporate profits. It's true that companies are getting a bargain. The government said that unit labor costs—namely, the amount of money that employers had to pay for each unit of workers' output—fell 3.6% over the past year, "the largest decrease since the series began in 1948." Bad for BusinessThe trouble is that with demand so weak, employers may not be able to enjoy the benefits of those lower unit labor costs, says Paul Ashworth, senior U.S. economist for Capital Economics in Toronto. Instead, competition for scant business may force them to pass along their labor savings to customers by cutting the prices of their goods and services. There could be, he says, a vicious cycle of falling prices and falling wages, worsened by the fact that Americans have huge debt burdens that loom larger when incomes fall. In a research note, Ashworth said: "The upshot is that deflation is still by far the biggest threat." University of Texas economist James Galbraith, in an e-mail message, says that "'Productivity' in this situation is a fairly meaningless construct," adding that the decline in hours "is not good for the working population." Galbraith said he sees "little reason for optimism" that economic growth will be strong enough to get employment back on track anytime soon. True, it's not wise to read too much into one quarter's numbers. Economic Policy Institute economist Josh Bivens notes that "productivity quarterly numbers get really kind of goofy and volatile around turning points in the economy," such as now. Also, some optimists argue that higher productivity growth will eventually encourage companies to do more hiring. "In the second half of 2010 businesses will accumulate a strong pent-up desire to add more high-quality workers into their teams," IHS Global Insight (IHS) Chief U.S. Financial Economist Brian Bethune said in a Nov. 5 report. But Capital Economics' Ashworth argues that the optimists on productivity are getting things backwards. The optimistic argument is that higher productivity will lead to more employment. But he notes that it was falling employment that caused the higher productivity in the first place. "People are basically saying the decline in employment is going to cause more employment," Ashworth says. And that is not a very good bet.
Coy is Bloomberg Businessweek's economics editor. His Twitter handle is @petercoy.

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