Smith Faculty Opinion Article	May 7, 2007
By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

U.S. Productivity Advances Solidly
Good News for Inflation, Interest Rates and Stocks

Today, the Department of Labor reported productivity in the nonfarm private business sector increased at a 1.7 percent annual rate in the first quarter of 2007. This was in line with the 1.6 percent increase recorded in the fourth quarter of 2006. (1.6).

Since the first quarter of 2006, productivity has advanced only 1.1 percent, and this is less than in recent years. The housing slump and higher energy prices have slowed GDP growth over the last two quarters, and rather than lay off workers, businesses have accepted a somewhat slower place of productivity advance. Nevertheless, in the first quarter, productivity growth at 1.7 percent, coupled with the 1.5 percent jobs growth, indicates GDP grew much more rapidly than the 1.3 percent reported by the Department of Commerce on April 27. GDP is likely to be revised up to 1.6 percent, perhaps higher, depending on the final trade deficit numbers, which will be reported on May 10.

Labor Costs, Inflation and the Stock Market

Hourly compensation increased 2.3 percent in first quarter, and unit labor costs, which factors in higher wages and higher productivity, rose 0.6 percent. This is a modest increase and is good news for the inflation watchers at the Federal Reserve. This increases the likelihood the Federal Reserve will leave interest rates unchanged until the fall.

Productivity growth fuels corporate profits by permitting U.S. businesses to maintain or widen margins on domestic operations. Also, U.S. businesses are taking their innovations abroad, and foreign operations account for significant shares of U.S. corporate sales and profits.

Overall, steady interest rates, productivity gains and new products, and profits from overseas operations should help push stock prices higher.

Better Productivity Growth Ahead

U.S. companies continue to bang out new products and more efficient methods for making goods and services. Little good evidence has been offered to explain why the process of accelerated innovation that began in the 1990s should dissipate now.

Productivity should surge as personal consumption expenditures and business investment drive up the demand for U.S. goods and services in the second half of 2006. Factoring in a one percent annual increase in the labor force, the economy could grow 3 percent a year with the right mix of fiscal, monetary and exchange rate policies.

The overvalued dollar limits productivity gains, because the resulting trade deficit shifts labor and capital from export and import-competing industries into other non-trade-competing activities. Trade-competing industries exhibit 50 percent higher labor productivity and spend much more on R&D than do the rest of the economy.

Also, the trade deficit shifts the production of new and innovative products offshore, reducing high-value employment immediately and increasing the likelihood that next generation products will be developed as well as made abroad.

Cutting the trade deficit in half would boost R&D spending enough to push sustainable productivity growth to about 3 percent per year, and raise potential GDP growth to about 4 percent.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.