Productivity growth better than expected in first quarter while labor costs keep falling

Productivity grows 3.6 percent in first quarter

WASHINGTON — Productivity growth posted a better-than-expected gain in the first three months of the year while labor costs dropped more than expected. That combination is good for corporate profits but means household incomes continue to be squeezed, putting the economic recovery at risk.

The Labor Department said Thursday that productivity grew at an annual rate of 3.6 percent in the first quarter. That was better than the 2.5 percent increase economists had expected.

Unit labor costs dropped at an annual rate of 1.6 percent, a bigger decline than the 0.7 percent forecast. It marked the third straight quarterly decline, underscoring how much a severe recession has dampened wage pressures.

A second report Thursday showed the job market is slowly improving. The Labor Department said applications for unemployment benefits dropped for a third straight week, decreasing by 7,000 to 444,000.

Economists believe the April jobless number, which is to be released Friday, will show unemployment stuck at 9.7 percent for a fourth straight month.

The economy has been growing since last summer but firms have been reluctant to hire back workers. They are instead opting to push their slimmed-down workforces to produce more.

That has translated into a surge in productivity. It grew at annual rates of 7.6 percent, 7.8 percent and 6.3 percent in the second, third and fourth quarters of last year.

The 3.6 percent rise in productivity for the first three months of this year marked a drop from the rates turned in over the last three quarters. That is something that economists expect will occur as companies reach the limit of how much they can expand output without hiring more workers.

Paul Ashworth, an economist at Capital Economics, called the 3.6 percent rise in first quarter productivity impressive. But he predicted slower productivity gains in coming quarters.

“Firms have been amazingly successful in cutting costs during the recession and the early stages of the recovery,” he said.

Many of those reductions were achieved through one-time savings such as closing less-productive plants, he said. As employment begins to rise, productivity gains should slow, Ashworth and other analysts said.

“Companies addressed the post-Lehman collapse in the economy with a massive wave of layoffs. With demand now picking up … they need to hire again,” said Ian Shepherdson, chief U.S. economist at High Frequency Economics.

Economists view the rehiring of workers as helping sustain the recovery because it boosts overall incomes. That allows households to increase consumer spending, which accounts for 70 percent of economic activity. The concern is that unless incomes start rising, consumer spending will not expand and the recovery could falter.

The 1.6 percent fall in unit labor costs followed declines of 5.6 percent in the fourth quarter and 7.6 percent in the third quarter. That indicates the deep recession has banished wage pressures for the moment.

For all of 2009, productivity, the amount of output per hour of work, rose at a 3.7 percent rate, nearly double the 2 percent increase in 2008. It was the fastest annual increase in productivity in seven years.

The strong gains in productivity and falling unit labor costs have kept a lid on overall inflation. That has given the Federal Reserve leeway to keep a key interest rate at a record low level for more than a year and help jump-start economic growth.

In the first three months of this year, the overall economy, as measured by the gross domestic product, grew at an annual rate of 3.2 percent. It was led by the strongest growth in consumer spending in three years. But the worry is that consumer spending could falter in coming months unless unemployment is reduced and the rising support spending.