By Alexander Kowalski and Ilan Kolet - Oct 19, 2011 6:02 AM GMT+0700
The world’s largest economy may need its second miracle in 15 years as waning productivity growth sets the stage for slower income gains, fewer job opportunities and larger federal deficits in the U.S.
Worker output per hour has fallen for two consecutive quarters, the first back-to-back decline since 2008, and Labor Department revisions show the measure remains below levels typical for this point in a recovery. Going forward, business efficiency will advance at only about half the 3.4 percent pace during the so-called productivity miracle of 1997 to 2003, according to economists at the Federal Reserve Bank of New York.
“This is not good news amid already dim prospects,” said James Kahn, chair of the economics department at New York’s Yeshiva University and a former central-bank economist who wrote about the deceleration on the New York Fed’s Liberty Street Economics blog. “An underlying trend of slow productivity growth has emerged, which means our baseline assumptions about economic growth may be a little too optimistic.”
A rise in worker efficiency of 1.5 percent a year would mean U.S. gross domestic product of $17 trillion by 2016 before accounting for inflation, said Kahn, who worked at the New York Fed from 1997 to 2008.
His estimate is $2.3 trillion less than the Congressional Budget Office forecast of $19.3 trillion. The difference is more than five times the $420 billion in output the U.S. lost during the 18-month recession that ended in June 2009, Bloomberg News calculations show. GDP was $15 trillion in the second quarter.
Contain Costs
As productivity growth fades, it will be harder for companies to contain costs, according to Julia Coronado, chief North America economist at BNP Paribas in New York. Slower growth also may stall a return to rising wages that boost consumer spending, low inflation that makes hiring new workers less expensive and corporate profits that propel stock values, she added.
Given the weakness, “I would not suggest drastically cutting fiscal policy in the near term,” said Rudy Narvas, a senior economist at Societe Generale in New York. If the government fails to extend the payroll-tax cuts and unemployment benefits that expire in December, it “could easily push the U.S. into recession next year.” A “credible” deficit- reduction plan also “needs to be in place for when economic growth stabilizes,” he said.
Diminishing Demand
To offset rising expenses and diminishing demand while productivity is low, U.S. multinationals will need to seek more business in emerging markets such as China and Brazil, where they can find “low-cost production without necessarily sacrificing quality,” said Mark Luschini, chief investment strategist at Philadelphia-based Janney Montgomery Scott LLC, which manages $54 billion.
He recommends consumer-staple and industrial companies including Procter & Gamble Co. (PG), 3M Co. (MMM) and Honeywell International Inc. (HON), which have growing shares of income from emerging economies where per-capita wealth and consumer spending are rising.
The deceleration in U.S. business efficiency contrasts with the booming period between 1997 and 2003, when investment in technology and a more educated workforce combined to create what economists and investors from Nobel laureate Paul Krugman of Princeton University to Pacific Investment Management Co.’s Bill Gross referred to as America’s “productivity miracle.”
Former Fed Chairman Alan Greenspan recognized early on that the acceleration could contain inflation, even as the economy gained strength and unemployment stayed low.
‘Unusual Era’
“The probability that we are in a very unusual era is rising,” which “argues that prices are in check for a while,” he said in the May 1997 meeting of the Federal Open Market Committee, according to the minutes. The Fed kept its benchmark federal funds rate between 4.75 percent and 5.5 percent from 1997 through 1999, while GDP increased an average 4.6 percent a year.
Ben S. Bernanke considered the gains “almost certainly the most important economic development in the United States in the past decade,” he said in a 2005 speech he gave as a Fed governor about a year before becoming chairman of the central bank. Surges in both consumer and investment spending followed the pickup, while employment rose and inflation remained “fairly stable” as advancing business efficiency held labor costs down, Bernanke said. Real disposable income rose by an average of nearly 5.6 percent annually, Commerce Department data show.
Budget Control
The expansion in the 1990s made it “an awful lot easier to get the budget under control,” Michael Hanson, a senior U.S. economist at Bank of America Merrill Lynch in New York, said in a telephone interview. The growth generated more revenue, and the annual budget deficit of $221 billion in 1990 became a surplus of $236 billion by 2000.
These benefits are scarce now, as the revised Labor Department figures underscore a loss of momentum. Worker output per hour rose at a 2 percent annualized pace between the fourth quarter of 2007, when the recession began, and the first three months of 2011. The original estimate was 2.7 percent. Productivity fell 0.6 percent and 0.7 percent in the first and second quarters of 2011.
This negative growth is another demonstration that the boom in the 1990s and a 2009-to-2010 burst of productivity growth “were more temporary than the start of a marvelous new age of invention,” Robert Gordon, a professor at Northwestern University in Evanston, Illinois, said in an e-mail. Gordon is a member of the National Bureau of Economic Research committee that determines the start and end dates for economic declines.
Rising Probability
Following the revisions, the probability that the U.S. is in a period of low productivity growth has increased to 90 percent from 40 percent, according to the research by Yeshiva University’s Kahn, which was co-written by Robert Rich, an economist at the New York Fed.
The model they used, which also takes into account labor compensation and consumer spending, shows growth in employee output probably will remain under 2 percent for the next five years. The slowdown indicates that estimates underlying the severity of the fiscal problem may “turn out to be overly optimistic,” said Harvard University professor Dale Jorgenson.
The CBO anticipates potential worker output per hour will advance an average of 2 percent a year until 2016 and then 2.2 percent annually until 2021. Forecasters combine projections for productivity and labor-force growth to determine the extent to which the economy can expand.
Aging Workforce
“It’s pretty clear at this stage that we are running under” forecasts and “are likely to continue to do so,” Greenspan said Sept. 21 in a discussion hosted by the New America Foundation in Washington. Because of the aging workforce and lower productivity, the congressional supercommittee charged with trimming the budget deficit by about $1.5 trillion in 10 years should cut as much as $6 trillion, he said.
“The economy can’t shoulder too heavy a burden, so you have to design policies very carefully that will produce the maximum benefit and help create or support industries that will be the growth engines of the future,” said BNP Paribas’s Coronado, who is a former Fed economist.
Output per employee hour will continue to lag behind until companies start spending more on technology and ideas that boost production without requiring more input, said Michael Mandel, chief economic strategist at the Progressive Policy Institute in Washington.
Business Investment
While business investment on equipment and software has increased by an average annual pace of 13 percent each quarter since the recession ended, Mandel calculates it’s 19 percent below where it should be, based on the 10 year average pre- recession trend.
That’s partly because of economic uncertainty, he said in a telephone interview. After growing by 3 percent in 2010, gross domestic product expanded at an average of less than 1 percent in January-June and is projected to rise 1.7 percent for the full year and 2 percent in 2012, based on the median estimates of economists surveyed by Bloomberg News.
There are signs the U.S. is gaining strength: Private payrolls climbed 137,000 in September, and retail sales rose 1.1 percent, exceeding forecasts. U.S. companies have money to spend on boosting productivity if the outlook continues to improve. The amount of cash and cash equivalents on hand at businesses in the Standard & Poor’s 500 Index has increased by nearly 60 percent in the past four years and now exceeds $1.1 trillion, Bloomberg data show.
“We’ve got to focus on investment in physical capital, investment in human capital and investment in knowledge capital,” Mandel said. “We’ve got to get productivity up.”
To contact the reporters on this story: Alexander Kowalski in Washington at akowalski13@bloomberg.net; Ilan Kolet in Ottawa at ikolet@bloomberg.net
To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net
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