Productivity Surged in First Quarter
8.6% Increase Indicates Recession Did Not Halt Improvement in Output

By John M. Berry
Washington Post Staff Writer
Wednesday, May 8, 2002; Page E01

Business productivity soared in the first three months of the year, scoring its biggest gain in nearly two decades as economic growth surged while the number of hours worked fell slightly, the Labor Department reported yesterday.

The figures indicate that last year's recession did not derail the rapid increase in productivity -- the amount of goods and services turned out for each hour worked -- that began in the second half of the 1990s, analysts said. Those gains in efficiency helped keep inflation low and allowed employers to raise workers' pay faster than prices, boosting Americans' standard of living.

On the other hand, in the economic recovery so far, the productivity gains have meant employers have been able to boost output without hiring many more workers. Thus, while the higher productivity is likely to lead to better profits and wage increases, it also means that many of the jobs that were lost during last year's slump won't be regained quickly -- a point underscored by last month's increase in the nation's jobless rate to 6 percent.

The Labor report said productivity at private businesses other than farms rose at an 8.6 percent annual rate in the first quarter, following a 5.5 percent rate of gain in the last three months of 2001. Since March 2001, productivity in the non-farm sector has increased 4.3 percent, faster than in any recessionary period in decades.

"The recent productivity numbers are pretty amazing," said economist Martin N. Baily, a productivity expert at the Institute for International Economics.

The fact that productivity is still advancing so strongly is one reason most Federal Reserve officials are generally not worried about inflation despite the hefty 5.8 percent annual rate of economic growth in the first quarter of the year. With productivity increasing, companies' labor costs are falling, which eases pressure to raise the prices they charge.

With inflation firmly in check, Federal Reserve officials yesterday left unchanged their unusually low 1.75 percent target for overnight interest rates. The decision was widely anticipated and had little impact on financial markets.

The officials, meeting as the Federal Open Market Committee, the central bank's top policymaking group, said in a statement that much of the spurt in first-quarter growth was due to increases in factory output required to halt a rapid liquidation of unsold goods. But the growth of consumer and business spending in coming months, "an essential element in sustained economic expansion, is still uncertain," the statement said.

The FOMC also made no change in its estimate of the risks the economy faces. Even though interest rates remain very low, the committee concluded that the risks are balanced with respect to its long-run goals of price stability and sustainable economic growth.

Six to eight weeks ago, many financial analysts were expecting the Fed to raise its target for overnight rates by now and to continue to do so throughout the remainder of this year. Now most analysts aren't looking for a rate increase until an FOMC meeting in August, and perhaps not even then, depending on the course of the economy.

Baily, the productivity expert, said that in the first four quarters following the beginning of recessions stretching back to 1973, productivity growth averaged a scant 0.25 percent, compared with the 4.3 percent gain this time.

"The surprising thing about the very strong recent numbers is that they did not come after a big plunge in productivity," Baily said.

The large gains in the last two quarters were partly the result of the cyclical rebound in production following last year's very mild recession. But with last year's decline so small, "the cyclical bounce-back in productivity could well have been very mild, too," Baily said. "Instead it has been very strong."

But Baily cautioned that as economic growth slows, as it is expected to do in the current quarter, so will the productivity gain.

Incorporating the latest data into as assessment of how productivity has performed since the middle of the 1990s, Baily cautiously estimates that the long-term trend in productivity growth appears to be running at about a 2.4 percent annual rate -- more than double what it was in the 1970s and 1980s.

Except for a small decline in the first quarter of 2001, productivity has increased continuously over the past two years despite the recession. During much of those two years, however, compensation per hour rose more rapidly, so that for several quarters in a row unit labor costs increased at a 4 percent to 5 percent annual rate. With competitive pressures particularly strong during the recession, firms were not able to pass those cost increases along in the form of higher prices, so their profits suffered. But with the productivity spurt over the past six month, that picture has changed sharply. Unit labor costs fell at a 3.1 percent annual rate in the fourth quarter and at a 5.4 percent rate in the first. Those declines slightly more than offset increases in the second and third quarters of last year. As a result, unit labor costs are down 0.9 percent since March 2001.