Eyeing the Lead-Foot Economy's Speedometer

Are You Experienced?

JACKSON HOLE, Wyo. -- And today we talk about tomorrow.

What is productivity?

Productivity is defined as output per hour of all persons.

Why does productivity matter?

The economy has a capacity to grow over time that is limited by the sum of the trend rate of growth in the labor force and the trend rate of growth in productivity.

In other words, trend gross domestic product growth equals trend labor-force growth plus trend productivity growth.

That is why productivity matters.

What does that have to do with the real world? With markets? With me?

Productivity is the thing that gave rise to the whole New Era debate to begin with. And, fittingly, it is the performance of productivity that will also settle it.

Specifically, trend labor-force growth sits at roughly 1.3%. So, if the investment boom that began in 1993 has permanently driven trend productivity to 3% from 1.1% during the 1980s, as New Era types contend, then the economy can continue to grow at a rate as big as 4.3% (1.3% plus 3%) without bumping up against capacity constraints -- the very constraints that produced price pressure during lower-productivity periods in the past.

Let that point sink in, for it is terribly important to understand: If the New Era description of today's economy is the right one, then we will not see the core (excluding food and energy) price measures accelerate.

Indeed. The whole New Era argument draws entirely on the performance of the economy between 1996 and 1998 -- a three-year period that delivered bigger growth increases alongside littler core price increases. So now, if the New Era really is for real -- if trend productivity really has surged, and if the superb growth-price combo we saw between 1996 and 1998 really does owe much more to New Era technology than it does to a host of temporary and favorable supply shocks -- then the core price measures ought to go right on posting littler increases, just like they did during the past few years.

Again, let that sink in. Economic growth has averaged a huge 4.1% lately, and that has policymakers worried. Yet if the New Era is for real -- if trend productivity growth has moved permanently to 3% (or more) -- then they needn't get their panties in a bunch. They needn't fret because the core price measures are not in danger of accelerating. In fact, if the New Era is for real, the core price measures will keep on posting littler increases.

Is productivity even more important now than it was just a month ago?

Well yes. Yes it is.

The Chairman recently made it so, and your narrator wrote about it in detail.

The following Greenspan quote sums things nicely.

Finally, while it is reasonable to conclude that some of the gains in output per hour (productivity) have been driven by fundamental forces, and are not only a cyclical phenomenon or a statistical aberration, it remains a wholly separate question of whether they can be extended. The rate of growth of productivity cannot increase indefinitely. While there appears to be considerable expectation in the business community, and possibly Wall Street, that the productivity acceleration has not yet peaked, history advises caution. ... For, if productivity growth should level out or actually falter because additional technology synergies fail to materialize, or because output per hour has been less tied to technology in the first place, inflationary pressures could re-emerge, possibly faster than some currently perceive feasible.

How enormous is the burden that now rests on the productivity numbers?

This enormous: It is not enough for them to preserve the gains they've already racked up; they've got to keep tacking them on at the same quick pace.

And if they don't, G. Love will be in to play that Harvey Keitel role.

You know. The Cleaner.

What do the latest productivity numbers look like?

They look like this.

Nonfarm Business Productivity Percentage change on a year earlier
When	Output	Hours	Productivity	Compensation	Labor costs
1990	0.7%	0.3%	0.5%	5.5%	5%
1991	(1.8)	(2.4)	0.7	4.9	4.2
1992	3	(0.1)	3.1	5.1	1.9
1993	3	2.9	0.1	2.2	2.2
1994	3.9	3.3	0.5	1.9	1.4
1995	3	2.4	0.6	2.4	1.8
1996	4.1	1.6	2.4	3.5	1.1
1997	4.5	3.2	1.2	3.5	2.3
1998	4.6	2.4	2.2	4.2	2
Q1 1999	4.4	1.7	2.6	4	1.4
Source: Bureau of Labor Statistics

The nonfarm productivity numbers shown in the table above are the popularly reported ones. Last year, a 4.6% increase in output less a 2.4% increase in hours worked yielded a 2.2% increase in this measure of productivity. (Note that subtracting labor costs from compensation produces the same result, and that not all calculations are precise due to rounding.) As of the first quarter of this year it was showing acceleration -- it was growing at a 2.6% rate during the three months ended March -- while growth in both hourly compensation (wages) and unit labor costs was showing deceleration.

And those are precisely the three things that the Fed wants to keep seeing; those are the things that will prevent it from tightening further.

Productivity for Nonfinancial Corporations Percentage change on a year earlier
When	Output	Hours	Productivity	Compensation	Labor costs
1990	1%	0.3%	0.6%	5.1%	4.4%
1991	(1.3)	(2.7)	1.5	4.5	3
1992	3	0.5	2.5	4.5	2
1993	3.4	2.3	1.1	2	0.9
1994	6.3	3.9	2.3	2	(0.3)
1995	4.4	3.2	1.2	2.1	0.9
1996	4.5	1.7	2.8	3.1	0.3
1997	6.1	3.6	2.5	3.5	1
1998	5.6	2.6	3	4.1	1.1
Q1 1999	5.4	1.6	3.7	4.4	0.6
Source: Bureau of Labor Statistics

The productivity numbers for nonfinancial corporations shown in the table above are the ones G. Love is known to strongly prefer. Last year, a 5.6% increase in output less a 2.6% increase in hours worked yielded a 3% increase in this measure of productivity. As of the first quarter of this year it was showing acceleration -- it was growing at a 3.7% rate during the three months ended March -- while growth in labor costs was showing deceleration and growth in compensation was showing acceleration.

Two of those things the Fed wants to keep seeing, and the other it doesn't.

What happens tomorrow?

The BLS releases the nonfarm productivity number for the second quarter. (The second-quarter number for nonfinancial corporations won't be available for another month.)

What is it likely to show?

Well, one of the biggest risks to the market right now is that productivity growth is no longer accelerating as fast as it has been. That it might even be leveling out -- that the productivity acceleration we have seen since 1996 will turn out to be mostly cyclical, not structural (and that it will slow materially when overall economic growth does).

And that is what tomorrow's number is likely to show.

Addenda

Two things to keep in mind.

One is that a subscription to New Era thinking has cost a fortune in bonds. New Era forecasters have been promising since last autumn that the Fed would not tighten (because it has no reason to) and that market interest rates are headed materially lower.

Nine months, one tightening, and 140 basis points later, they are still swearing the same thing today.

The other is that during the advanced stages of the 1961-1969 boom -- the expansion that most closely resembles the wave we've been riding since 1991 -- it took only four quarters for productivity growth to decelerate by a full three-and-a-half percentage points.

How about that.

A miracle that suddenly proved not very miraculous.

Side Dish

And all sincere thanks to my colleagues for the write-ins that appear under the poll.

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