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ECI's No Alpha and Omega

Think the Employment Cost Index is the be-all and end-all in determining inflationary pressures? Don't believe the hype.

"We all grew up learning labor costs are an important source of labor problems," said James Glassman, senior U.S. economist at

Chase Securities

. "In the 1990s, the various regions of the globe are so out of sync that labor costs aren't the central issue."

The market has been waiting on this figure since Federal Reserve Chairman

Alan Greenspan's

lengthy discussion on the labor market during his

Humphrey-Hawkins

testimony two weeks ago. But economists say the threat of increased imports from Asia and dampened demand for U.S. products means any rise in labor costs could be short-lived.

During this economic expansion, productivity growth has remained strong on a year-over-year basis. Benefits costs have been held in check as medical benefits were shifted to HMOs; companies have outsourced work less essential to production.

The trend of declining benefits costs may be over. And when the Asian credit crunch loosens, domestic employers will need to stay competitive with cheap Asian imports by further improving productivity, or corporate profits will be undercut.

"The problem is that the Employment Cost Index is no longer an advance indication of inflation because businesses do not have pricing power in the new global economy," said Philip Braverman, senior vice president and chief economist at

DKB Securities

.

The consensus forecast for this figure -- 0.8% to 0.9% -- is a bit higher than the 0.7% rise in the first quarter. Greenspan did say a pickup in labor costs could result in wage pressures, but late in his prepared remarks he said a number of factors, including problems in Asia, could engender a transition to a "more sustainable rate of growth and reasonable balance in labor markets."

If labor costs increase, companies aren't going to respond by increasing prices. "What this crisis will do is speed the shift toward diversifying production everywhere," said Glassman. The competitive pressures from Asian imports have already shown their effect in the textile, apparel, energy and other commodity sectors, where the strong dollar and falling commodity prices have hampered domestic pricing power.

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The U.S. has been able to mitigate this through the declining cost of capital equipment and investment in emerging technologies. Greenspan gave a nod toward this, saying these benefits are "evident not only in high-tech industries but also in production processes that have long been part of our industrial economy."

The increased level of productivity, which Glassman called "understated," has kept costs in check even as this country has seen the unemployment rate fall below 5% -- and stay there -- for a full year. Hourly earnings are up 4.1% on a year-over-year basis as of June, about the same as the February 1997 4% figure.

The rise in labor costs in Thursday's report may be most pronounced through increased benefit costs. The trend of shifting medical benefits to HMOs, which lowered costs in the last few years, has wound down. (

TheStreet.com's

economics correspondent,

James Padinha

, discussed this in a

piece last week.

"Companies have been successful in holding down health care costs, which is the largest piece of benefits costs," said Ken Mayland, chief economist at

KeyCorp

in Cleveland. "That may have run its course, although the evidence is mostly anecdotal. The clearest indication of this is the large losses suffered by many insurers this year."

Producers would react to rising labor costs by trying to raise productivity without incurring more costs that will drive corporate profits down. Measures include cutting workers, outsourcing, moving plants to other North American companies through the

North American Free Trade Agreement

or putting facilities in other countries to assemble goods and ship them to the U.S.

"So far, it's been easy," Braverman said. "We're heading into a tougher time because the downward pressure on prices will be more intense. It's ironic that the U.S. has thus far been protected from international competition as a result of the Asian meltdown by the credit crunch in Asia."

The crunch has prevented Asian producers from producing goods at prices as low as they otherwise could. While the trade deficit has widened to a record level of $15.8 billion, this is more a function of falling exports than increased imports. Exports are at their weakest since 1986, and although imports continue to increase, especially from Asia (up 6.8% year-over-year as of May), economists say this figure will worsen.

"We're seeing a pipsqueak increase in wages, and focusing on that as if it is going to bring down the house of cards of the disinflationary trend, without recognizing that there's going to be a tidal wave of imports to inundate manufacturers over the next couple years," Braverman said.