For the really bad news, we'll have to wait until Friday morning, when the July jobs report is released. (Actually, most of you reading this will probably already have heard the bad news.) But Thursday's news on the inflation front was already dismaying. The Department of Labor reported that nonfarm business productivity rose just 1.3 percent in the second quarter, after a 3.6 percent leap in the first. Along with that came news that unit labor costs leapt 3.8 percent in the second quarter, after a minuscule 0.8 percent increase in the first.
A rise in labor costs is, of course, a good thing for American workers, most of whom are still seeing only slight increases in their real income. But a rise in labor costs without a concomitant rise in labor productivity is generally taken as a sign that inflationary pressures are in the offing. (If they're not, then corporate profits are going to take a serious hit.) Today's numbers were not disastrous. But assuming that the jobs report is as good (or, rather, bad) as is expected, meaning that hundreds of thousands of new jobs were created in July, a Federal Reserve interest-rate hike now seems like a foregone conclusion.
Productivity is the key economic statistic, because only increases in productivity can increase the ability of the economy to grow without the artificial boost of inflation. The more output we get per worker-hour, the more income per hour each worker can earn. If productivity were to remain stagnant, then the economy could grow only as fast as the size of the work force grew. But when, as in the last three years, productivity increases at a 3 percent annual rate, the limits of the economy are extended.
Output per worker hour may seem slightly esoteric, but in fact it's the ideal measure of productivity because it makes explicit the heart of all economic growth: the conversion of time, through labor, into value. The only way an economy can become something more than a bunch of people taking in each other's washing, that is, the only way an economy can actually improve living standards and increase the collective wealth, is when one of two things happens: Either people work more hours, changing empty time into a product or service, or people create more value with those same hours. In a booming economy like this one, people do both.
The slowdown in productivity, then, doesn't bode well for those who assumed that the economy could keep growing at 4 percent indefinitely without sparking inflation. And yet it was striking that, confronted with this news, the bond market, which is usually hypersensitive to the possibility of inflation, did not sell off. In fact, bonds rallied, with yields dropping to 6.04 percent.
You could say that this was just irrational. But when you look a little deeper at the productivity numbers, the evidence for real inflationary pressures starts to look rather sketchy. On a year-over-year basis (rather than quarter-to-quarter), nonfarm productivity was up 2.9 percent, compared to 2.7 percent in the first quarter, and unit labor costs were up just 1.4 percent. (Again, what's important is that increases in productivity outpace increases in labor costs. Though not by too much.) So, from that perspective the economy doesn't appear to be overheating.
Still, the combination of this report and last week's Employment Cost Index (which showed worker compensation rising faster than at any time since 1991) should throw at least a hint of caution into the New Economy advocates, those who are convinced that inflation is permanently dead and that the computer has forever revolutionized the productivity equation. We're still in the middle of a remarkable run. But a boom built on productivity improvements is real. A boom built on easy money is not. And distinguishing betweeen the two is the most important thing Alan Greenspan can do right now.