The latest US data for first-quarter
non-farm output, coming in strongly above the
consensus forecasts, is good news for inflation,
interest rates and stock prices.
The
Department of Labor on Wednesday said productivity
in the nonfarm private business sector increased
at a 2.2% annual rate in the first three months
this year. The consensus forecast was 1.5%, and my
published forecast was 2.0%.
Productivity
has advanced 2.5% since the third quarter of 2006
and remains quite strong in the critical
manufacturing sector.
Continued strong
productivity growth helps keep inflation in check
in the face of rising oil
and commodity prices, and accommodates moderate
wage growth.
The Federal Reserve can focus
on the subprime crisis and stabilizing credit
markets, without fear of creating inflation
pressures beyond those imposed by international
oil and commodity markets and outside the effect
of Federal Reserve actions.
Federal
Reserve forecasts indicate inflationary pressures
should abate in the months ahead. The veracity of
those forecasts will hinge on global developments
and not be much affected by Federal Reserve
actions
Credit markets are stuck. The
major New York banks and primary securities
dealers can no longer bundle mortgages and
business loans into bonds, because insurance
companies, pension funds and other fixed income
investors no longer trust Wall Street financial
houses.
Consequently, regional banks,
which rely on New York financial houses to resell
their loans, have limited ability to extend credit
to qualified home buyers and worthy businesses. To
correct this situation, the Federal Reserve needs
to take bolder steps than those so far talked
about by the Federal Reserve, Treasury and foreign
central banks. Robust productivity growth give the
Federal Reserve needed room to act much more
decisively.
Labor costs, inflation and the
stock market Hourly compensation
increased at a 4.2% annual rate in the first
quarter, and unit labor costs, which factor
together higher wages and productivity, increased
2.2%.
Productivity growth will remain
strong in the second quarter, while wage pressures
are moderating. Strong productivity growth permits
moderate wage increases that pose no significant
threat to accelerate inflation. Thanks to rising
productivity, wage pressures should not constrain
Federal Reserve interest rate setting policy.
Prospects for inflation remain mostly
determined by foreign oil prices, and cost
pressures in China's manufacturing, which supplies
a significant share of US consumer goods. A
significant revaluation of the yuan against the
dollar would reduce pressures both on global oil
supplies and wages in Chinese manufacturing, and
do much to constrain global inflation.
At
its June policy setting meeting, the Federal
Reserve will weigh the impact of the subprime
crisis on the housing market and broader economy.
Observers expect the Fed to keep the target
federal funds rate at 2%, but this week's
productivity data give the Fed latitude to further
reduce interest rates if economic conditions
warrant.
Productivity growth fuels
corporate profits by permitting US businesses to
maintain or widen margins on domestic operations.
Also, US businesses are taking their innovations
abroad, and foreign operations account for
significant shares of US corporate sales and
profits.
Overall, falling interest rates,
productivity gains and new products and profits
from overseas operations should help support stock
prices. The stock market will remain volatile but
should trend upward overall, especially in the
second half of 2008.
Better productivity growth
ahead? US companies
continue to bang out new products and more
efficient methods for making goods and services.
In the first quarter, manufacturing productivity
was up 4.1% and at a 3.7% rate since the third
quarter of 2006. In the critical durable goods
sector, which builds out many of the breakthroughs
in information technology, productivity was up at
a 4.5% annual rate since the third quarter of
2006.
These trends indicate US durable
goods manufacturers and technology-based services
should be gaining global market share. But for
China's undervalued yuan, US durable goods
manufacturers would not be losing market share and
jobs to Asian competitors, and but for arbitrary
restrictions on US investment, the presence of US
services providers in China should be larger.
Productivity should continue to advance,
and looking beyond the adjustments associated with
the subprime crisis, the growth potential for the
US economy remains formidable. Factoring in a 1%
annual increase in the labor force, the economy
could grow 4% a year with appropriate Federal
Reserve and Treasury policies to reform Wall
Street Banks and securities dealers, and the right
mix of fiscal, monetary and exchange rate
policies.
The overvalued dollar against
the Chinese yuan, Japanese yen and other Asian
currencies limits productivity gains because the
resulting trade deficit shifts labor and capital
from export and import-competing industries into
other non-trade-competing activities.
Trade-competing industries exhibit 50% higher
labor productivity and spend much more on research
and development than do the rest of the economy.
Also, the trade deficit shifts the
production of new and innovative products
offshore, reducing high-value employment
immediately and increasing the likelihood that
next-generation products will be developed, as
well as made, abroad.
Cutting the trade
deficit in half would boost research and
development spending enough to push sustainable
productivity growth to about 3% per year, and
raise potential gross domestic product growth to
about 4%.
Peter Morici
is a professor at the University of Maryland
School of Business and former chief economist at
the US International Trade Commission.
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