NAROFF ECONOMIC ADVISORS, Inc.

Joel L. Naroff
President and Chief Economist

INDICATOR: Fourth Quarter 2011 Productivity/Unemployment Claims

KEY DATA: Nonfarm Productivity: +0.7%; Unit Labor Costs: +1.2%/Claims: 367,000 (down 12,000); 4-Week Average: 375,750 (down 2,000)

IN A NUTSHELL: “As is the usual case, with employment rising, productivity is moderating and that is raising labor costs.”

WHAT IT MEANS: Businesses have worked extraordinarily hard this recovery to restrain all costs but especially labor expenses. They have done so by working employees harder and longer and that has paid off in large increases in productivity and earnings.

Those days are slowly fading as job growth is picking up. The new workers must be trained and at least until demand rises faster, there is somewhat less for each worker to do. Thus, we are now in the normal productivity slowdown phase.

Output by each worker grew in the fourth quarter at less than half the pace posted in the summer period. The biggest decline was in manufacturing, which has been gearing up to deal with rising sales. That sector went from robust increases to decline.

The slowdown in productivity has some major implications for business costs. Worker compensation is rising and even adjusting for inflation, it actually improved at the end of 2012. For all of 2011, productivity rose at the slowest pace since 2008.

If you want to know why consumer demand has not surged, just look at the compensation numbers: Hourly compensation adjusted for inflation fell by 1.2% in 2011. It’s hard to buy more when your spending power is being diminished.

Even with the moderation in productivity, it looks like hiring will remain on the rise. Weekly unemployment claims fell and the trend level has reached a point where the unemployment rate should go down if not monthly, fairly steadily.

MARKETS AND FED POLICY IMPLICATIONS: Usually you have to give up something to get something and that is the case with jobs. As payroll gains accelerate, productivity normally eases, raising business costs but also increasing worker compensation.

That we are seeing that happen should be cheered as the consumer is the centerpiece of this economy. More jobs mean more income and as the unemployment rate declines, wage gains accelerate. That will provide the means to greater consumption and economic growth.

So both the productivity and unemployment claims numbers, when taken in tandem, paint a picture of an economy recovering. The Fed acknowledged that the labor market was beginning to improve but discounted any major drop in the unemployment rate. The accuracy of that forecast will determine the ability of the FOMC to keep rates low until the end of 2014.

I think unemployment rates will fall faster than the monetary authorities do so I expect rates to rise well before that date. Since tomorrow is employment Friday, we only have a few hours to wait until we see how the year started off but not matter what number prints, the decline in the claims numbers does point to an improving labor market that will ultimately show up in more jobs.

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