As Expected, ULC and Productivity Both Deteriorated

First quarter non-farm productivity was revised down to 1% from 1.7%, and unit labor costs were revised up to +1.8% from +.6% previously. So, with productivity falling and labor costs rising, the Fed will remain concerned about inflation and growth. Soft productivity growth tends to lower the non-inflationary potential growth rate of the economy.

Productivity measures output per employee hour worked. Quarterly productivity growth peaked at +10.4% quarterly annualized growth in 2003, and fell into negative territory briefly in 2005 and 2006. Last quarter's level is near the four quarter average of .95%, but below the 20 quarter (5 year) average of 2.6% quarterly annualized growth pace. Fourth quarter productivity was left unchanged at a +2.1% quarterly annualized rate. For the entire year of 2006, non-farm productivity rose +1% YoY, this is a notable slowing from the +3.1% annual average growth rate from 2000-2005. In contrast to total productivity, manufacturing productivity rose in the first quarter to +2.4% annualized versus +1.9% annualized in the fourth quarter. Non-financial productivity, which is monitored by the Fed, rose +.6% annualized in the first quarter.

A change in how bonus payments and stock options are accounted for caused labor costs to decelerate in the first quarter from the fourth quarter. Though compensation rose +2.8% annualized in the fourth quarter (versus an initial estimate of +2.3%), when adjusted for inflation, real compensation fell -1% annualized in the first quarter. This compares to a real compensation growth rate of +13.6% annualized in the fourth quarter, and a recent high. But when looking over a longer time horizon, to account for the changes in compensation timing and computation, it is clear that compensation is growing faster than inflation.

Unit labor costs measure compensation versus output growth, and are adjusted for efficiency gains. With GDP being revised lower (+.6%) in the first quarter, and output growing at a four year low, and compensation rising, it is not surprising that unit labor costs rose, even as hours worked fell (-.4%), the most in four years. The 1.8% annualized increase in ULC for the first quarter is a substantial slowing from the +8.9% revised rise in the fourth quarter increase for non-farm businesses. ULC for manufacturing grew +4.5% annualized in the first quarter. Durable goods producers saw their ULC rise even faster, to +6.2% annualized, as wage gains outstripped productivity improvements. Non-financial ULC rose +4.1% annualized in the fourth quarter, and have risen +3% YoY.