Labor Costs Rise at 2.2% Rate,Creating Inflationary Pressure - May 6 2005

Pickup Marks TurnaroundFrom 2002, 2003 Restraint;Grounds for More Tightening
By JON E. HILSENRATH Staff Reporter of THE WALL STREET JOURNAL
Labor costs are creeping up modestly for U.S. companies, providing a source of some inflationary pressure.
The Labor Department reported that unit labor costs -- a measure of the labor cost attached to each widget a company produces -- rose at a 2.2% annual rate for nonfarm businesses in the first quarter, a pickup from the 0.4% increase registered in all of 2004. The increase was driven in part by higher compensation costs. While wage growth remains restrained for many workers, high benefit payments are also a source of compensation increases.
The government also reported that the productivity of workers -- measured as output per hour worked -- grew at a 2.6% rate in the first quarter. That marked a pickup in productivity growth from the two previous quarters, though the pace is no longer at the lofty rates that prevailed shortly after the recovery took hold, when companies were cutting costs aggressively to boost the bottom line.
"Businesses are more focused on looking for growth opportunities now that they've recovered a little bit from the effects of the downturn," said Martin Baily, a productivity expert at McKinsey & Co.
The growth in unit labor costs marks a turnaround from 2002 and 2003, when companies were able to squeeze labor costs by restraining wages and hiring even as they increased the output of existing workers.
Labor costs are an important component of inflation and one in which Federal Reserve officials take great interest. As labor costs rise, executives have an incentive to push prices higher to protect profit margins. Because wages remain restrained and other measures of compensation are tame, it isn't clear that labor costs will move much higher. But economists said the latest report gives the Fed, which raised its key short-term rate to 3% Tuesday, more reason to keep nudging rates higher.
A slowdown in productivity growth is also at hand. Between the end of 2001, when the recovery started, and the second half of last year, productivity grew at an annual rate of around 4.5%, the strongest stretch of growth in nearly 40 years. But recently it has settled to a growth rate well below 3%. While still a healthy rate, it means companies aren't able to push their work force as much as they had been.
Another government report showed the number of workers filing first-time applications for unemployment benefits rose last week for a second week in a row. Initial jobless claims increased by 11,000 to 333,000, the Labor Department said. But economists said that didn't change their view that employers expanded nonfarm payrolls by about 200,000 jobs over the course of April.