Productivity Data Hints at Improved Hiring Outlook

Revised data shows that the slowdown in worker productivity during the second quarter was larger than expected, which could put more pressure on businesses to increase their profitability in the second half of 2010.

Business productivity for non-farm businesses was revised sharply downward to 1.8% in the second quarter on Thursday, compared to the 0.9% decline originally reported. It marks the first quarterly decline after five straight quarters of rapid productivity growth.

"We don't expect productivity to keep declining, but it's clear that it has become much more difficult for employers to extract ever more output from their existing workforces," says Nigel Gault, chief U.S. economist for IHS Global Insight.

Evidence of Investment

To offset the decline in productivity and maintain profits, most experts say businesses will likely have to invest in equipment to improve worker productivity, hire more workers, or work their current workforces even harder.

There is evidence that companies have already started to make investments in equipment. Business equipment and software spending rose 21.9% in the second quarter, the second consecutive quarter with growth over 20%. This trend toward increased business spending could be a response to the decline in worker productivity or a reaction to an increase in business demand.

Whether companies will begin hiring more workers is still an open question. Andrew White, CFO of consulting firm Sageworks says that many private firms have successfully adjusted to operating with fewer workers because they've had to maintain their cash and profit margins in an environment where they couldn't borrow from banks. White said private firms are spending "a lower amount of payroll per dollar of revenue they produce than they have historically, so they are probably running with underemployment."

A Reluctance to Hire

While these private businesses could probably use more workers, White doubts they will begin to hire until they see a significant increase in revenues, most likely driven by consumer spending.

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"If we see increases in revenues," White says, "then [businesses] will be willing to make some investment, they will be more confident and they will be able to let their profit margin decline a bit and make some investments in hiring people to get back to a normal employment level."

IHS Global Insight chief economist Nariman Behravesh suggests that companies have already begun hiring – but very gradually.

"Going forward we will continue to see employment gains, but they will be fairly modest, mostly because companies are still being pretty cautious," Behravesh says.

Looking Ahead

Behravesh projects monthly job gains of 50,000 to 75,000 for the rest of 2010, then, says hiring should gradually increase to 100,000 to 120,000 jobs per month at the start of 2011. By the end of 2011, Behravesh says job gains should average 150,000 each month – finally reaching the level economists say the economy needs to average to make any significant dent in the unemployment rate.

In fact, the projected slow growth in jobs will mirror the slow growth economic growth, Behravesh says.

"We expect the second half this year to be fairly weak," he says. "Consumers and businesses are being extremely cautious. They are worried about the recovery and they feel a little jittery, so they're just taking their time... It's not that they are cutting back spending -- they're not, but they're also not spending at a very rapid pace."

Without spending to drive revenues higher, hiring will likely lag as well.