Productivity gains in 2Q due mainly to cost cuts

By MARTIN CRUTSINGER, Ap Economics Writer

WASHINGTON – Companies managed to boost their workers’ productivity and their own profits in the spring mainly by slashing costs and capping their employees’ pay.

That was clear from revised government figures released Wednesday that provided further evidence that a tentative economic recovery has begun, while also reinforcing nagging concerns. Analysts worry the tight job market and lack of wage growth will depress incomes, limit further corporate profitability and forestall a pickup in all-important consumer spending.

Bill Schultz, chief investment officer at McQueen, Ball & Associates in Bethlehem, Pa., said companies that have shed workers and squeezed out savings won’t be able to show the big profit gains they did last quarter by relying on more big cuts. Having already made deep reductions, companies will need to find ways to generate more revenue.

“Profits have recovered nicely, but it’s more the way that they have recovered that gives people pause,” Schultz said. “The key is to somehow blend this cost-cutting with revenue growth.”

Productivity — the amount of output per hour of work — rose at an annual rate of 6.6 percent in the April-June quarter, the Labor Department said. That’s the largest advance since the summer of 2003. And it’s slightly better than the 6.4 percent productivity increase the government had estimated last month.

At the same time, labor costs fell at an annual rate of 5.9 percent — the sharpest drop since 2000 and slightly more than the 5.8 percent drop estimated a month ago.

Economists said the rising productivity and lower labor costs supported their view that the longest recession since World War II is coming to an end.

Mark Zandi, chief economist at Moody’s, said it’s “very typical” for productivity to surge at the end of a recession as businesses aggressively cut costs.

Economists say they don’t expect productivity to keep surging. But they said the productivity jump in the second quarter, combined with falling labor costs, might persuade employers to slow their pace of layoffs and eventually resume hiring.

That is critical because until the labor market heals, consumers probably won’t step up their spending. And consumer spending, which accounts for about 70 percent of economic activity, is a vital ingredient in any sustained rebound from the recession. A dismal job market makes that prospect uncertain.

On Friday, the government will report the unemployment rate for August. Economists expect the rate to tick up to 9.5 percent, from 9.4 percent in July, and that a net total of 225,000 jobs were lost in August, down from 247,000 jobs lost in July.

The jobless rate is widely expected to top 10 percent by next spring, before a recovery is strong and sustained enough to push that rate down. During this period, the economy also faces the risk that a recovery would falter and the economy would fall back into recession.

“This is always a tricky transition, and there are many things that could still derail the economy given that the labor market is still very weak,” Zandi said.

William Rutherford, president of Rutherford Investment Management LLC in Portland, Ore., agreed that companies don’t have much leeway to cut costs without hurting vital parts of their businesses. Sustained profitability will require higher revenue, he said.

“They’ve done a lot of cutting of jobs,” Rutherford said. “They’ve gotten their inventories down under control. I think from here on out we’re going to have to see some top-line growth.”

With the recession showing signs of ending, Federal Reserve policymakers last month felt comfortable slowing the pace of its program to buy Treasury securities and putting off any major changes to other programs, according to minutes of their discussions released Wednesday.

But a “poor” jobs market, evaporated wealth, hard-to-get credit and stagnant wages mean consumers are still facing “considerable headwinds,” the minutes said.

“With these forces restraining spending, and with labor income likely to remain soft, (Fed) participants generally expected no more than moderate growth in consumer spending going forward,” the minutes stated.

On Wall Street, the improved report on productivity and labor costs did little to ease worries about future economic prospects. The Dow Jones industrial average lost nearly 30 points and broader indices also edged down. The Dow lost 186 points on Tuesday.

In a separate report, the Commerce Department said factory orders rose 1.3 percent in July. That was the fifth gain in the past six months and further evidence that manufacturing is starting to pull out of its nosedive.

An 18.5 percent jump in transportation goods drove the overall increase as aircraft orders surged after a big plunge the previous month. Orders for new autos grew by 5.1 percent as sales jumped, thanks to the Cash for Clunkers government incentive program. But orders for nondurable goods, such as food, petroleum products and chemicals, fell 1.9 percent, the most since December.

The factory orders report followed a positive reading on manufacturing activity Tuesday. That report showed that the sector grew in August for the first time in 19 months, according to a survey by the Institute for Supply Management.

The 6.6 percent rate of increase in productivity in the second quarter compared with a 0.3 percent rise in the first quarter. It was the largest increase since a 9.7 percent jump in the third quarter of 2003.

The 5.9 percent drop in unit labor costs followed a 5 percent decline in the first quarter.

Rising productivity and falling labor costs might be expected to bolster the competitiveness of U.S. companies against foreign competition. But with the U.S. productivity gains mainly due to companies trimming costs more sharply than their output was falling, exports aren’t expected to rise significantly.

Analysts said once a recovery takes hold and demand begins to rise, output will finally increase and laid-off workers can be rehired.

“In the long run, the best way to increase productivity is to increase output, especially in areas where the United States has a competitive advantage, such as high-technology goods,” said Sung Won Sohn, an economist at California State University’s Smith School of Business.


AP Business Writers Christopher S. Rugaber and Jeannine Aversa in Washington, and Tim Paradis in New York contributed to this report.