Productivity Growth Slower in 2006, Though Gains Made in 4th Quarter

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Productivity, the most important ingredient in rising standards of living, increased in 2006 at the slowest rate in nine years while labor costs shot up at the fastest rate in six years.

Productivity, the amount of output per hour of work, rose by 2.1 percent for all of 2006, down slightly from a 2.3 percent increase in 2005. It was the slowest pace since a 1.6 percent gain in 1997. However, the year ended on a brighter note with productivity growing at an annual rate of 3 percent in the fourth quarter, nearly double what economists had been expecting.

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Labor costs for each unit of output rose 3.2 percent for all of 2006, up from a 2 percent increase in 2005 and the fastest rise in worker wages and benefits since a 4.2 percent increase in 2000.

For the fourth quarter, wage pressures eased a bit, rising by just 1.7 percent, a better outcome than analysts had been expecting following a 3.2 percent rate of increase in the third quarter.

While rising wages are good for workers, the concern is that if those increases outstrip gains in productivity, then businesses will start raising the price of their products, setting off a classic wage-price spiral.

The Federal Reserve is keeping close tabs on the performance of productivity and unit labor costs for any signs that slowing productivity and rising wage pressures are having an adverse impact on inflation. The hope is that businesses will meet worker wage demands by trimming their record profits rather than boosting the cost of their goods.

Currently, inflation has been well-behaved, with underlying inflation pressures starting to recede following last year's surge in energy prices. Many economists believe as long as the spike in energy prices does not spread to wage demands, the Fed will be content to remain on the sidelines as it did last week when it left rates unchanged.