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Productivity Declines, Labor Costs Rise
Joe Richter in Washington


March 7 (Bloomberg) -- The productivity of U.S. workers fell last quarter for the first time in almost five years and labor costs rose, adding to concerns that employment gains and faster wage growth will fuel inflation.

Productivity, which measures employee efficiency, declined at an annual rate of 0.5 percent after rising at a 4.2 percent pace in the previous three months, revised Labor Department data showed in Washington. Labor costs increased 3.3 percent, the most in a year.

Growth in productivity has slowed as companies squeeze as much as they can from their workers and equipment. Limits on employers' ability to meet demand are encouraging them to hire more and may lead them to offer bigger paychecks to attract and keep qualified help, economists said.

``Businesses will be adding workers, so productivity growth will stay modest in 2006,'' said Michelle Girard, senior economist at RBS Greenwich Capital Markets in Greenwich, Connecticut. ``The increase in unit labor costs is something the Federal Reserve is aware of, and it adds to the case they're going to continue raising rates.''

Merrill Lynch & Co. economists today raised their federal funds rate forecast for this year, following a similar move by Lehman Brothers Holdings Inc. last week. A shift in expectations has boosted the dollar and led to a slump in emerging stock markets on concern the increase in U.S. borrowing costs will slow the global economy.

First Quarter

Productivity may rebound this quarter as economic growth picks up. At the same time, economists said such gains may prove short-lived.

``Productivity will be stronger in the first quarter, but the trend is still toward moderating growth this year,'' said Joel Naroff, president of Naroff Economics Advisors in Holland, Pennsylvania.

A separate report today showed that consumer borrowing increased in January by the most in four months as Americans picked up the pace of spending. Consumer credit, or non-mortgage loans to individuals, rose $3.9 billion during the month after a $3.4 billion rise in December, the Fed said.

Economists expected a 0.1 percent decline in fourth-quarter productivity after a 0.6 percent decrease that the government reported last month, according to the median estimate of 64 economists surveyed by Bloomberg News. Labor costs were expected to rise 3 percent.

Rising demand is prompting General Dynamics Corp., the fourth-largest maker of business jets, to spend $300 million over seven years to expand manufacturing and service facilities in Savannah, Georgia. The Falls Church, Virginia-based company's plans include the addition of about 1,100 jobs to the 4,300 already employed at the facility.

Employment

The percentage of chief executives at small and mid-size companies expecting to increase hiring rose to 64 percent in the first quarter from 61 percent, according to a survey from TEC International released today. San Diego-based TEC International is a provider of executive training and development.

Hours worked rose at a 2 percent pace in the fourth quarter compared with a 0.4 percent increase in the previous three months, today's Labor Department report showed. Output increased at a 1.5 percent rate after a 4.7 percent third-quarter gain.

Among manufacturers, productivity rose at a 4.7 percent pace after rising at a 3.7 percent rate in the third quarter. Productivity at U.S. non-financial corporations, a measure watched by the Fed, rose at a 4.1 percent rate in the third quarter. Those data are reported with a one-quarter lag.

For all of last year, productivity increased 2.9 percent, the slowest since 2001. It rose 3.4 percent in 2004. Labor costs rose 2.6 percent last year after a 1.1 percent rise in 2004.

Fourth Quarter

The productivity figures represent an improvement from the initial productivity estimate because a Feb. 28 report showed stronger economic growth in the fourth quarter than the government first estimated.

The Commerce Department report last month showed gross domestic product, the value of all goods and services produced in the U.S., rose at a 1.6 percent rate in the fourth quarter, compared with an initial calculation of 1.1 percent.

The report also showed that wages and salaries in the third quarter were $20.7 billion more than the government previously estimated. Labor costs from July through September increased at a 1.2 percent annual rate, up from a previously reported 0.5 percent decline.

Fourth-quarter economic growth was still the weakest in three years. The U.S. expanded at a 4.1 percent annual rate in the third quarter.

Record Expansion

Productivity growth averaged 2.1 percent a quarter during the 10-year expansion from 1991 to 2001. That average jumped to an annual rate of 3.3 percent since the first three months of 2002, the first full quarter that followed the end of the last recession. Productivity growth averaged 3.8 percent a year from 2002 to 2004, the best three years since 1949 to 1951.

In the 1990s, former Fed Chairman Alan Greenspan championed the idea that higher productivity rates would keep a lid on inflation even as the U.S. economy was gaining strength and unemployment was low.

American employers added 193,000 workers in January and the unemployment rate fell to 4.7 percent, the lowest since July 2001, as the U.S. economy strengthened. Capacity use at the nation's factories in January rose to 80.5 percent, the highest since July 2000.

Less spare capacity and increased demand for workers has the attention of Fed policy makers.

``We have to be careful here as we approach full utilization of our resources,'' because of the potential for inflation to accelerate, Philadelphia Fed Bank President Anthony Santomero said after a Feb. 23 speech.

Fed

The Fed on Jan. 31 raised its overnight lending rate a quarter point to 4.5 percent, the 14th straight increase.

The outlook for stronger economic growth and a building of inflation pressures have prompted economists to raise their forecast for the overnight bank lending rate target.

Merrill Lynch said today that the funds rate will rise to 4.75 percent, up from 4.5 percent, and stay there through June. Last week, Lehman Brothers economists raised their forecast for a peak in the rate to 5.5 percent in August or September, up from its earlier 5 percent estimate.

The economy will grow this quarter at the fastest rate in more than two years, according to a survey released Feb. 27 by the National Association for Business Economics. The economy will expand at an annual rate of 4.5 percent from January through March, the group forecasts.

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