Recent figures show the fourth-quarter productivity surge exceeding expectations, while tamped-down unit labor costs may calm fears of inflation
As comebacks go, this was a pretty good one. A government report released Feb. 7 showed that U.S. nonfarm productivity jumped 3.0% in the fourth quarter—well above economists' median forecast of a 2.2% increase—following the subdued 0.1% decline in the third (revised down from a 0.2% gain). The ramp-up in productivity was accompanied by a moderation in unit labor costs, which slowed to a 1.7% pace in the fourth quarter, from a revised 3.2% increase in the third (previously 2.3%).
Both figures were welcomed by financial markets, as they point to continued strength in the overall economy without stepped-up wage inflation.
Fourth-quarter output climbed 4.2%, more than doubling its 1.9% third-quarter pace (revised up from 2.3%), and is consistent with the surprisingly strong fourth-quarter gross domestic product gain of 3.5%. Hours worked slipped to a 1.2% rate from 2.0% (revised from up 2.1%). Compensation per hour surged, up 4.8%, helped by hefty bonus payments. It was up a revised 3.1% in the third quarter (up 2.6% previously).
On a year-over-year basis, productivity accelerated to a 2.1% pace vs. 1.3% from the third quarter (revised from 1.4%), which had represented the lowest growth rate since the second quarter of 1997. Unit labor-cost growth slowed to 2.8% from 3.1% (revised from 2.9%).
Nice and Easy
While underlying growth in productivity remains solid, 2006 saw increased midcycle pressures that damped productivity growth and pushed up unit labor costs as the expansion matured. Though productivity is posting a cyclical moderation as we move past the high-growth quarters of the early expansion years, and compensation costs are trending upward, both patterns are proving less abrupt than the markets and the Fed feared earlier in the year. Indeed, despite the third-quarter productivity downswing that drew considerable attention from market commentators, the gyrations last year mostly reflected quarterly swings in the GDP figures.
The surge in hourly compensation revealed in the report is likely part of an emerging seasonal tendency for big bonus-led gains in the fourth and first quarters, at the expense of the second and third. The bonus impact through yearend is usually exacerbated by later revisions in the second- and third-quarter reports, and we assume that this will be the case this year as well.
In total, the productivity data for 2006 beat market and Fed expectations despite the third-quarter "head fake" to leave an optimistic outlook for U.S. growth, and less inflation risk from rising wages. Though the Fed is likely still concerned that real GDP growth may be exceeding the productivity and labor force "speed limit," and that rising wage growth is boosting inflation risks, the fourth-quarter productivity report suggests that both risks may be less than assumed after the less encouraging third-quarter figures were reported. We at Action Economics expect a productivity gain near 1% in the first quarter.