Productivity rose at the fastest pace in more than a year last quarter, and while the numbers don't reflect any real strength in the economy, they do suggest that corporate America is prepared to adjust to a slowing economic environment.
Business productivity rose at an annual pace of 2.7% in the third quarter after climbing 2.2% in the second quarter, according to the Labor Department. That was far better than analysts' 2% estimate and the fastest pace since the second quarter of 2000. Although nonfarm business output actually fell 1% in the quarter -- the biggest drop since 1993 -- workers' hours fell an even greater 3.6%, resulting in the productivity gain.
"The jump in productivity came out of weakness, but the fact that businesses were able to reduce hours more than output underscores the flexibility in the economy," said Kathleen Stephensen, senior economist at Credit Suisse First Boston. "The question is what the Sept. 11 shock will be."
The most recent productivity numbers do not reflect October employment data, which showed a drop of 415,000 in nonfarm payrolls, analysts noted.
Joe Liro, chief economist at Stone & McCarthy, is looking for productivity to grow at a slower 1.5% pace in the fourth quarter and 1.3% in the first quarter of 2002. But he expects it to pick up in the remaining quarters of 2002, saying that the "New Economy, secular productivity story is still very much intact."
Many analysts have attributed the economic strength and low inflation of recent years to an increase in worker productivity. The idea is simple: If workers are becoming more productive, companies can sell more goods and increase profits without having to boost prices.
"Corporate management said they were committed to maintaining cost reductions and profit margins, and in an environment where they have absolutely no pricing power, they've delivered very handsomely," Liro said.
The average growth rate of productivity in the past two quarters was 2.4%, which compares favorably with the 1.8% average in the previous two quarters.
This "suggests the productivity cycle may now be turning up," according to Ian Shepherdson, chief economist at High Frequency Economics.
"At the same time, the compensation numbers are slowing, up 4.5% in the third quarter, the smallest rise since the fourth quarter 1999, so unit labor costs growth is slowing. These trends will intensify once the economy turns, thereby easing inflation concerns for 2002," he noted.
Unit labor costs increased 1.8% in the period, below the previous quarter's 2.6% climb. While a reduction in labor costs can keep inflation in check, it also has the potential to subdue personal spending.
Maury Harris, chief U.S. economist at UBS Warburg, said the data are "far better than usual for a recession period," emphasizing that productivity has "improved permanently since the mid-1990s, thanks to high capital expenditures and rapid technological innovation.
"The productivity gain, coupled with slower growth in compensation costs ... limited the cyclical erosion in profit margins. This strong gain in productivity underscores that long-term growth prospects for the U.S. remain solid, as
Alan Greenspan argued in Tuesday's
Fed directive," Harris said.
In the Federal Reserve's policy statement that accompanied the half-point rate cut Tuesday, Fed policymakers said that spending on security could restrain advances in productivity growth "for a time," but that the longer-term prospects remain favorable.
Still, David Gitlitz, president and chief economist of DG Capital Advisors, said he finds little to cheer in Wednesday's productivity data.
"What we're seeing is an unwinding of the phenomenon we saw in the late 1990s, when everyone that could work was getting hired," he said. "Now the least productive people are being hurt the most."
In most previous recessions, Gitlitz noted, productivity declined as output fell faster than hours worked. That's because most companies are usually reluctant to let go of workers only to have to rehire them later when the economy improves. This time, however, hours worked are falling faster than output as the unusually tight labor market continues to unwind, he said.
"It's a statistical artifact, and at some point output will start declining faster, so productivity numbers will look as bad as the real situation is," he said.
Separately, the Commerce Department reported that wholesale inventories fell 0.1% in September to $297.92 billion, compared with a revised 0.2% drop in August. Meanwhile, wholesale sales dropped 1.3% to $226.13 billion, following a revised 0.5% gain in August.
The inventory-to-sales ratio, a measurement in months of how long it would take companies to work through their inventory, rose to 1.32 from 1.30 in August.