The productivity "miracle" rolled on today as the government's preliminary report showed second-quarter productivity rose 1.1%. That's down from 8.6% in the first quarter but well ahead of the 0.7% consensus forecast. Moreover, the first-quarter data were revised upward from 8.4% previously. That first-quarter productivity was revised upward and second-quarter data bested expectations had optimistic economists gushing. "Cost-cutting initiatives are producing even greater savings than previously thought," said Mark Vitner, senior economist at Wachovia Securities. "That is good news for corporate profits and the inflation outlook." Such analysis omits several nagging issues. First, the data are subject to revision, as are all government reports. To wit: The annual average rate of nonfarm business productivity growth was lowered to 1.1% from 1.9% for 2001 and to 2.9% from 3.3% in 2000, according to today's report . Second, there's the question of just how first-quarter productivity rose and second-quarter productivity exceeded expectations despite the recent GDP report , which showed downward revisions to the former and punk results for the latter. As you'll recall, the widespread expectation was the lower GDP would take a bite out of productivity. "Given downward revisions to business output, that would have called for downward revisions" to first-quarter productivity, said Paul Kasriel, chief U.S. economist at Northern Trust of Chicago, who was "personally surprised by the 1.1%" second-quarter results. The economist said the somewhat inexplicable productivity numbers were due to a dramatic cutback in nonfarm hours worked, specifically a (revised) 2.2% quarter-to-quarter drop in the first quarter and a 0.7% decline in the second. Productivity is the sum of the growth in output, which rose by 0.5% in the second quarter, and hours worked, which fell. "The real test for the economy will occur when hours begin to rise again," Wachovia's Vitner commented, proving he's not a complete Pollyanna. "Then we will see how much of the 1990s' productivity revolution carries over into this decade." What caused the overall hours worked to drop was a big decline in hours worked by the self-employed, Kasriel observed. "I thought second-quarter productivity was going to be less and the missing piece of information was this labor input by self-employed," he said. "Who the hell knows how many hours they work? We don't really know how many hours the people in the employment survey were working -- that's a guess. It's an even bigger guess how many hours the self-employed were working, but according to the Bureau of Labor Statistics, they cut back on hours quite dramatically." The economist was quick to point out he doesn't believe the BLS was being devious or deceitful. The "big story" in today's data was that there was a "very significant decline" in second-quarter productivity vs. the first quarter, accompanied by a "fairly significant speed up" in unit labor costs, by 2.4% vs. a revised drop of 4.6% in the first quarter and expectations for a rise of 2%, he said. "Putting those together, that would suggest that corporate profits that the government will someday report shouldn't be too good." The real mystery, Kasriel said, is that "we take these numbers as important. It's ludicrous."
Feedback (Fruit) Loops
Of course, one reason these data are deemed important is Federal Reserve Chairman Alan Greenspan's obsession with productivity. Today's "good news" on the inflation outlook presumably gives the central bank more leeway to lower rates. However, a consensus is rising that the Fed will not lower rates at its policy meeting next week, as signaled for several days by fed-fund futures and confirmed for many by separate stories in The Wall Street Journal and The Washington Post today. The stock market's rally this week has, in part, been fueled by speculation about additional Fed easing. However, the rally has eliminated the presumed urgent need for a still-lower fed-funds rate. Completing this perverse feedback loop, the stock market was meandering a little bit Friday afternoon as the expectations for easing dwindled. As of 2:24 p.m. EDT, the Dow Jones Industrial Average was up 0.5% to 8725.31, the S&P 500 was up 0.2% to 907.14 and the Nasdaq Composite lower by 0.3% to 1312.74. "Predicting Fed policy is not high science, just watch the stock market," quipped Jim Bianco, president of Bianco Research in Barrington, Ill.