In surprise, productivity falls and labor costs jump

You can now add productivity and unit labor costs to the growing list of investor concerns for the U.S. economy.

U.S. Q4 2008 worker productivity unexpectedly fell at a -0.4% annualized rate and unit labor costs surged an alarming 5.7%, the U.S. Labor Department announced Thursday.

For all of 2008, productivity increased 2.8%, the largest productivity increase since 2003. Still, although solid, that level represents a downward revision in Q4 2008 productivity from the previous 3.2% Labor Department estimate -- which suggests the recent U.S. GDP slowdown is hurting output on a per-person basis. In 2007, productivity increased 1.4%.

Economists surveyed by Bloomberg News had expected productivity to increase 1.5% in Q4 2008 and unit labor costs to rise 3.4%.

Meanwhile, hours worked in Q4 declined at an 8.3% annual pace, the largest drop since 1975. Output fell at an 8.7% annual rate, the most since 1982.

Unexpectedly high labor costs

Economist Peter Dawson told DailyFinance Thursday the unexpectedly low productivity statistic probably reflects companies retaining slightly too many employees given the slump in demand. The higher unit labor cost stat is harder to explain, he said.

"During recessions, wage pressures usually dip, if not disappear altogether, so the 5.7% annualized rate increase for unit labor costs is a little puzzling. Perhaps it reflects higher overall costs for energy and materials that fed into the system earlier, but honestly, we're at a loss to explain the increase," Dawson said. "But let's not jump to conclusions and say there's a rising labor cost trend until we see Q1 data. The Q4 2008 data could just be an anomaly."

Productivity measures output per hour worked. Economists say rising productivity usually leads to increases in personal income, as businesses can increase wages paid without increasing their per unit costs. While quarterly productivity statistics are important, most economists focus on the longer, multi-quarter trend, as it's more indicative of overall efficiency and output strength.

U.S. productivity averaged about 2.7% during the 1948-1970 period, then slumped to 1.6% in 1971-1995. However, starting in 1995 the technological revolution driven by the personal computer, microprocessor, and the internet, among other breakthroughs, propelled a large increase in productivity to about 2.5% per year.

Economic Analysis: Two surprising stats, with labor costs being the most puzzling. Slightly lower productivity in Q4 is understandable, given the drop in demand in Q4 2008, due to the recession; the labor cost jump is hard to explain. As economist Dawson noted, perhaps it is an anomaly or was caused by some other idiosyncratic factor, such as large severance payments or bonuses. We'll get a better picture of the labor cost trend when Q1 2009 data is released later this year.
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