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U.S. Productivity Growth Declines - An Opportunity for Ben Bernanke?

Prof. Peter Morici - 9/7/2006

Yesterday, the Department of Labor reported productivity in the nonfarm private business sector increased at a 1.6 percent annual rate in the second quarter from the first quarter of 2006. This was an upward revision from the 1.1 percent preliminary estimate published August 8. On a year-over-year basis, second quarter productivity in the nonfarm business sector was up 2.5 percent. That is a solid performance and indicates the growth potential of the U.S. economy remains formidable.

The 1.6 percent second quarter productivity gain was sharply lower than the 4.3 percent jump scored in the first quarter; however, the poor second quarter estimate does not point to a trend but rather reflects the erratic nature of quarterly productivity data.

The absence of substantial inflationary pressures, outside the volatile energy sector, indicates the second quarter dip was temporary. Only strong productivity growth would permit nonfinancial corporations and manufacturers to continue posting gains in profits while paying higher wages and raw material prices.

Importantly, nonfinancial corporations posted a 2.2 percent gain in the second quarter over the first quarter, and 4.8 percent increase on a year-over-year basis. Rising interest rates hurt performance at banks and other financial companies, and this pulled down the average for second quarter productivity growth for the entire economy.

Outlook for 2007

The superior performance of nonfinancial corporations indicates productivity growth is likely to re-emerge in the third and fourth quarters.

The productivity performance of U.S. factories remained particularly encouraging. Manufacturing productivity advanced at a 2.6 percent annual rate over the first quarter, and for durable goods, productivity grew at a 3.7 percent annual rate. The year-over-year growth rates for all manufacturers and durable goods were 3.7 and 6.0 percent, respectively.

Steady interest rates and moderating energy prices are setting the stage for resurgent productivity and GDP growth in the fourth quarter and first half of 2006.

A stock market rally will provide a leading indicator of better times ahead.

Sustaining Permanently Strong Growth

The continued strong performance in manufacturing goods raises serious questions about the large trade deficit, and difficulties U.S. companies encounter competing with imports and winning export markets. Superior productivity performance, especially in durable goods, indicates U.S. competitive performance in global markets is held back by an overvalued dollar, federal budget deficits, skyrocketing health care costs, ineffective U.S. energy policies, and regulatory burdens imposed by Washington.

Were the Chinese yuan and other Asian currencies revalued against the dollar, the shift in resources toward export and import-competing industries to reduce the trade deficit would give productivity a significant jolt, because these industries exhibit 50 percent higher labor productivity growth and spend much more on R&D than the rest of the economy. Cutting the trade deficit in half would boost R&D spending enough to push sustainable productivity growth to 3 to 3.5 percent per year, and potential GDP growth above 4 percent.

Sadly, President Bush’s current policy agenda offers little hope that the Administration will take significant steps to remedy these pressing problems. His proposals are reworks of previous initiatives and palliatives.

Rising productivity notwithstanding, outsized federal budget deficits, the overvalued dollar, uncontrolled health care costs, and ineffective energy development policies make the Federal Reserve’s responsibility to maintain both growth and price stability much more difficult

With inflation moderating in the months ahead Ben Bernanke has a golden opportunity to speaking out on these vital issues.

Strong performance in nonfinancial sectors indicates the growth potential of the U.S. economy remains closer to four percent than the three percent now expected. We can accomplish that with the right monetary, fiscal, exchange rate, energy, and health care policies.