Unit labor costs rise faster than productivity in 4th quarter revisions

Final data on 4th quarter productivity and labor costs were released this morning.  The data shows that productivity was revised slightly higher to +1.9%, from +1.8% previously, as hours worked fell more than output.  This is still a sharp decline from the extremely robust +6.3% pace of the 3rd quarter, but is right at the average for the past eight quarters.  Productivity is a measure of how much the average employee produces in an hour, or how efficient they are.  Manufacturing productivity fell in the fourth quarter to +2.3%.  For all of 2007, productivity improved, growing by +1.8% YoY versus only +1% YoY in 2006.

 

Unit labor costs, which are adjusted for productivity, rose much more than expected.  Rising by +2.6% in the 4th quarter versus the expected, and previously announced, increase of +2.1%.  The good news here is that prior quarters gains were revised down, lowering the increase in labor costs.  Once again, the quarterly increase was right in line with the average for the past two years.  At an annual growth pace of around 2.5% for the past two years, unit labor costs are rising at around the same pace as core inflation.  Though the trend is rising as ULC for all of 2007 rose +3.1%.

 

Labor costs account for approximately 2/3rds of the production cost of an average good or service.  Employers have two main methods for cutting labor costs - either cut workers or hours worked, or increase their productivity.  Hours worked took their biggest tumble since the first three quarters of 2003, falling -1.6% in the fourth quarter.  Most of the decline was observed in hours worked by the self-employed.  Meanwhile, hourly compensation rose by +4.6% in the 4th quarter versus +3.4% in the 3rd quarter.  An economic slowdown is likely to keep wage growth subdued, even as inflation is rising.

 

Productivity and ULCs are determined based on the total output of the economy, as indicated by GDP.  GDP fell substantially in the 4th quarter to only a +.6% annualized growth pace from the robust +4.9% growth of the third quarter.  A slowing economy will encourage businesses to continue to protect profits by cutting labor costs and encouraging further productivity gains.  Unfortunately, productivity tends to fall when the economy slows.  This will put labor growth in jeopardy, though it will help skilled workers who are more efficient.