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BIG PICTURE:Productivity Gains Won't Last;That's Good For Jobs 11/05 02:41 PM



NEW YORK (Dow Jones)--The third-quarter productivity gain was a stunner. Don't expect it to last.
Companies will have to add workers instead of cutting costs as demand, fueled by government spending, picks up. If they don't, businesses risk cutting their most productive workers.
It can be hard to know when that line is crossed, especially when a payroll numbers in the tens of thousands, but laying off the best workers short-circuits the drive for more efficiency. For the economy as a whole, hiring will have to pick up in order to make the recent increase in demand shift from the government to the private sector.
Output per hour worked jumped at an annual rate of 9.5% last quarter, the biggest gain since 2003, according to data released Thursday. The increase in manufacturing alone was 13.6%, the highest on record.
With productivity up, unit labor costs fell, by 5.2%. During the past four quarters, unit costs have declined 3.6%, the largest decrease since the the U.S. Labor Department began tracking the data in 1948. Sharply falling unit labor costs powered the gain in profits last quarter.
The third-quarter data are also good news for the Federal Reserve, said Brian Bethune, chief U.S. financial economist at IHS Global Insight. "With inflation subdued, the [Federal Open Market Committee] has more latitude to keep rates at exceptionally low levels for an extended period," he said.
But economists caution the productivity surge cannot keep going. The increase came from drastically cutting hours even as output increased, thanks to stimulus programs like the "cash for clunkers" program.
"Productivity gains that result from cost cutting rather than capital investment and training are unsustainable," said Mark Vitner, senior economist at Wells Fargo Securities.
That's because cost cutting cannot go on forever, and cost-cutting businesses risk chopping muscle along with fat. Vitner said, "laying off the most value- added workers actually ends up reducing the company's productivity."
But efficiency gains based on integrating new technology and machinery can keep increasing, he said. That's what happened during the long productivity boom of the 1990s when the Internet and other new technology revolutionized the way companies exchanged information, managed inventories and distributed their products.
Economists at Morgan Stanley calculate that when expected benchmark revisions are included, private sector payrolls are now lower than in mid-2003 when private jobs bottomed out after the last recession. Yet real output is about 10% higher today than at that point. The Morgan Stanley economists conclude, "If companies want to push output higher, as now seems likely, they are going to have to start to add some labor." Morgan Stanley forecasts job growth will turn positive in early 2010.
But companies will try very hard to hang onto the efficiency gains already won, said manufacturing conglomerate Eaton Corp. (ETN:$64.48,00$2.09,003.35%) Chief Executive Alexander Cutler. In his view, that tenacity could limit the possibility of job gains in early 2010.
He said Eaton is unlikely to do any net hiring until the end of 2010 but the company also will not repeat the furloughs of four-week unpaid time off it required in 2009.
All things being equal, that will mean an increase in work time that will slow productivity gains. But it also will lift the earnings of Eaton workers. For demand to pick up in a sustainable way, household income needs to rise.
That would be good, said Joel Naroff of Naroff Economic Advisors, because what the economy needs is more confident consumers and businesses. Then the U.S. can shift out of the government- and Fed-supported growth and into a private sector recovery.
(Kathleen Madigan, a special writer, is the primary author of the Big Picture column. She has been writing about the economy for over two decades at BusinessWeek and Wall Street firms. She can be reached at 212-416-2466 or via email at [email protected].)
(Andrew Dowell contributed to this column.)
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(END) Dow Jones Newswires
11-05-091540ET
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