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November 2, 2000

U.S. Productivity Rose at 3.8% Pace in Third Quarter; Labor Costs Gained
By Siobhan Hughes, Bloomberg

As Productivity Slows, Inflation Accelerates ... Weiss comments

WASHINGTON - The productivity of American workers rose in the third quarter at a slower pace than the prior three months, while labor costs accelerated more than expected, a government report showed today.

Productivity, a measure of worker output for every hour on the job, rose at a 3.8% annual pace in the third quarter after a revised 6.1% second-quarter rate, the Labor Department said. Businesses reduced worker hours as output slowed in the third quarter.

Compensation per hour worked rose at the fastest pace since the first quarter 1992, Labor officials said. That could concern Federal Reserve policy-makers, who have signaled they see productivity gains continuing to offset labor costs.

"The jump in compensation costs is a major disappointment," said Mark Vitner, senior economist at First Union Corp. in Charlotte. The report suggests "as the economy slows inflation will likely increase and the Fed will likely be forced to keep policy on hold."

Unit labor costs, a gauge of wages per measure of output, rose at a 2.5% annual rate in the third quarter after falling at a revised 0.2% rate in the second. The third-quarter increase in labor costs was the largest since a 4.3% jump in the second quarter of last year.

Compared with last year's third quarter, labor costs rose 0.1% after falling 0.4% in the second three months of the year.

Analysts expected a 3% rise in productivity for the third quarter and a 1.5% increase in unit labor costs.

At issue is whether the smaller gains in productivity will continue. One negative sign was a report last week showing business investment in equipment and software -- which enhance productivity -- slowed to a 8.5% pace of growth in the third quarter, down from a 17.9% second-quarter rise. That dims the outlook for productivity.

"We did see a little more slowdown in investment spending in the third quarter," said Tim McGee, chief economist at Tokai Bank Ltd. in New York. "That does raise some questions about the sustainability of the pick-up in productivity."

In a sure sign that the Fed's "soft landing" attempt may be derailed, productivity growth is slowing to a crawl and inflation is clearly surging. Federal Reserve members have repeatedly stated that productivity growth is the only reason that wage-related inflation has not gripped the economy -- and the major reason that the Fed hasn't raised interest rates.

Today's report shows that labor costs soared at their fastest pace in 8 years. Productivity growth is no longer offsetting the wage demands of a tight labor market. What's more, investments in equipment and software that enabled more efficient output has dried up -- meaning productivity gains will slow even more in the future.

Skyrocketing oil prices are already enough to trigger a rise in interest rates. Add wage-related inflation to fuel-related inflation, and there is little choice for the Fed; it will have to raise rates by early next year.

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