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Pulp Fiction: The New Era Growth/Productivity Squeeze

Some people expect productivity to keep up its breakneck clip even as growth (supposedly) slows.

The Way You Squeeze My Lemon



literature is littered with references to profit margins.

The Humphrey-Hawkins testimony delivered in July 1998.

Given that compensation costs are likely to accelerate at least a little further, productivity trends and profit margins will be key to determining price performance in the period ahead.

The remarks delivered to the National Association of Business Economists in October 1998.

As a consequence of steady price levels, we have seen some very modest pressure on profit margins, which have been going down over the last two or three quarters, really. This has been a very unusual phenomenon, because it's been my experience over the years that when we are dealing with falling or moving profit margins, moving down in the context of still fairly good business activity, that price pressures tend to become difficult to deal with. It's not happening now, and the major reason, at least from a strict statistical balancing, is that the productivity data are behaving far better than I think any of us expected.

The testimony delivered to the Ways and Means Committee in January.

Despite brisk demand and improved productivity growth, corporate profits have sagged over recent quarters. This is attributable in part to some acceleration in labor compensation, but other factors have also been pressing, especially intensified competition and lower prices facing our exporters and those industries competing with imports. In these circumstances, businesses will feel under considerable pressure to preserve profit margins should labor costs accelerate further, or should the falling prices of commodity inputs, like oil, turn around. But, to date, businesses' evident pricing power has been scant. Either that would change and inflation could begin to mount or, if costs could not be recouped, capital outlays might well be cut back.

The Humphrey-Hawkins testimony delivered in February.

Another downside risk to the economic outlook is that growth in capital spending, especially among manufacturers, could weaken appreciably if pressures on domestic profit margins mount and capacity utilization drops further. And it remains to be seen whether corporate earnings will disappoint investors, even if the slowing of economic growth is only moderate. Investors appear to have incorporated into current equity price levels both robust profit expectations and low compensation for risk. As the economy slows to a more sustainable pace as expected, profit forecasts could be pared back, which together with a greater sense of vulnerability in business prospects could damp appetites for equities.

And the testimony delivered to the Joint Economic Committee in June.

For the period immediately ahead, inflationary pressures still seem well contained. To be sure, oil prices have nearly doubled and some other commodity prices have firmed, but large productivity gains have held unit cost increases to negligible levels. Pricing power is still generally reported to be virtually nonexistent. Moreover, the re-emergence of rising profit margins, after severe problems last fall, indicates cost pressures on prices remain small.


Bureau of Economic Analysis

released second-quarter profit margin figures this morning.

Technical note.

You can calculate the numbers in the table above yourself by heading to

Table 12 in the latest

gross domestic product

release. Margins equal profits divided by (in this case) the gross domestic product of nonfinancial corporate business (620/4,883.7). Alternately, unit profits from current production divided by price per unit of gross domestic product (0.135/1.064) yields (roughly) the same result.

Margins peaked at 13.8% during the third quarter of 1997 (a performance went down as a 30-year best) but have generally been falling since. Members of the bonds-and-fed-funds-are-both-going-to-4% crowd cheered on the release of first-quarter figures, but the second-quarter numbers failed to provide a fresh squirt of New Era enthusiasm.

In fact, margins fell between 1997 and 1998, and they are likely to fall again between this year and last.

Demand is positively thumping -- witness

personal consumption

, which rose at a 4.6% (annual) rate during the second quarter and, because


growth is still soaring, is unlikely to slow significantly anytime soon.

Labor markets are tightening even further as a result -- witness recent


numbers, which keep rising, and recent

unemployment insurance


numbers, which keep falling.

Wages are being bid up even more as a result -- witness


, which is

growing at a 4.3% year-on-year rate (a full 1.4 percentage points faster than productivity).

And now what seems more likely?

That productivity growth will continue to accelerate by another percentage point every year or two -- and hold down unit labor costs and prices in the process?

Or that productivity growth will slow or level out -- and continue to pressure unit labor costs and prices?

And hey. Wanna hear something really weird?

Not only are the


and the New Era types banking on big productivity numbers to keep the miracle going, but they are also counting on them to hold up even under the material deceleration in growth they continue to forecast (and, in the case of the Fed, try to engineer).

Growth is going to slow but productivity isn't?

How bout them apples?

Moby Dick

So the most pathetic member of the

Tool Juniors

lot is born-again Bullish (capital B) on bonds. He's a big buyer. He says today that "bonds look good."

Gotta love the timing, right? Now that yields have already dropped almost 40 basis points from their Aug. 10 highs?

And it's even more priceless considering the track record here.

    December 1998 Given our belief that the economy is slowing and that there is a significant risk of a sharp stock market correction, we remain bullish on Treasuries. January 1999 The 30-year yield should trend lower toward the 5.00% mark. February 1999 Until and unless inflation reverses course and trends higher, the Fed will not tighten and bonds will not enter a long-term bear market. March 1999 The fact is that all signs are still pointing to disinflation, which means that the Fed won't tighten and bond yields are not headed back to 6%. May 1999 The market might not yet embrace our confidence that noninflationary 4% growth is possible, but bond yields aren't heading to 6% unless inflation does truly accelerate. Tightening will therefore remain a threat, but nothing more.


Keep that Latin phrase in mind. Caveat whatever.

Bring It On Home

The following nugget appeared today in a

Wall Street Journal


That's how the world works according to the Phillips Curve, an economic model that seems to loom large in the Fed's private antique collection but has offered no useful predictive power in the marketplace for more than 20 years.

What a truly ignorant thing to say.

Your narrator is happy to meet publicly -- anytime, anywhere -- with the nugget's (unnamed) author to discuss the Phillips Curve concept and its predictive power.

Side Dish

Four months ago I wrote that "I am fundamentally bearish on bonds (meaning I think the next move in the fed funds rate, whenever it comes, will be up) and fundamentally bullish on the economy (meaning I think growth will prove stronger during the third and fourth quarters, on average, than it will during the first and the second quarters)."

My position has not changed.

I also wrote that "the consumption math sure looks like it will play out such that growth will decelerate between the first quarter and the second. Spending finished the first quarter just like it began it: with a bang. So, given that the March level of consumption sits so high, it would take some kind of Herculean effort on the part of Americans to spend enough in April to give the second-quarter consumption number a shot at rivaling the first."

That turned out to be a pretty good call.

And you know what?

Big deal.

You shouldn't care much at all about my position, and you shouldn't care much at all about how my calls turn out.

Unlike traders, analysts, strategists and economic forecasters, I am not paid to predict the future. I am a columnist; I am not paid to be right.

I am paid to make you think.

I link you to everything I look at so that you're free to come to your own conclusions.

You're wise to do so.


OK. Check out the

contestants (and their bios) and lay your bets.

And the winner is?





District of Columbia.