The Productivity Puzzle (excerpt)

There is widespread concern about the slow growth in nonfarm business productivity. Over the past 20 quarters (five years) since Q1-2010, it is up only 0.5% on average during each of the Q1-to-Q1 periods spanning this period: 0.4% through Q1-2011, 0.9% through Q1-2012, 0.5% through Q1-2013, 0.6% through Q1-2014, and 0.3% through Q1-2015. That’s awfully weak growth.

There are lots of different reasons to be concerned. Fed Chair Janet Yellen is worried that wage gains are being held down by weak productivity. Bond investors are worried that inflation might rebound if tightening labor markets push up labor costs, with wages rising faster than productivity. In this scenario, stock investors would fret that profit margins would be squeezed if labor costs rise faster than prices. Progressives are saying that companies are using their cash and borrowings to buy back their shares rather than invest in productivity-enhancing capital equipment. They claim that’s worsening income inequality.

In other words, everyone wants to see productivity growing at a faster pace. The key reason is that productivity is the key determinant of consumers’ purchasing power (i.e., real income) and the standard of living (i.e., consumption). However, there are measures of these two variables suggesting that the productivity problem may not be as serious as widely believed. Consider the following:

(1) Long term. First, let’s keep in mind that technological innovations--which are the key drivers of productivity--tend to be lumpy. They don’t happen continuously over time, and they take time to be adopted once they are ready for prime time. We can see this by looking at the growth in productivity over 24-quarter periods. Since the early 1950s, productivity grew especially fast during the 1960s and the late 1990s and the first few years of the next decade. Before and after these bursts, the pace of productivity growth was relatively subpar.

(2) Short term. On a shorter-term basis, productivity jumped 5.2% from Q1-2009 through Q1-2010 before the slowdown since then. That boosts the average productivity growth rate a full percentage point to 1.3% per Q1-to-Q1 period over this six-year time span. I constructed a good proxy for productivity by dividing real GDP by the average weekly hours index in the private sector. I did so because there are no official productivity measures for goods and services industries in real GDP.

I constructed proxy measures of productivity in goods and services industries by dividing their contributions to real GDP by their average weekly hours indexes. Both proxies jumped during 2009. Goods productivity has continued to trend higher at a slower pace, but services productivity has dropped 5.7% from Q4-2009 through Q1-2015! That seems very odd and suggests that the government’s bean counters may be having an especially tough time counting the beans in services.

(3) Freebies. “[T]he U.S. doesn’t have a productivity problem, it has a measurement problem.” That’s according to a 7/16 WSJ article titled “Silicon Valley Doesn’t Believe U.S. Productivity Is Down.” It reviews the contrarian views of Hal Varian, Google’s chief economist. The article notes, “[T]he only way goods and services move the official U.S. productivity needle is when consumers and businesses pay for them. Anything free, no matter how much it improves everyday life, isn’t included.” Many of today’s time-saving technologies are free, like some location-based apps, cloud computing, and robust search engines.

On the other hand, the first posted comment about the article observes: “I suspect that all the productivity gains provided by Google and the like are more than offset by the ridiculous amount of time people spend on FaceBook, Twitter, Instagram etc writing about the cute thing their dog did today, or posting a picture of what they had for lunch...”

Today's Morning Briefing: Opie Kicks the Can. (1) The best can kickers on the road. (2) Going fishing on a summer’s day down a country road. (3) Mario and Opie. (4) Between “aw, shucks” and “shock and awe.” (5) Another panic sell-off followed by another relief rally. (6) Marty Zweig’s famous mantra on steroids. (7) Another better-than-expected earnings season, especially ex-Energy. (8) Putting together the pieces of the productivity puzzle. (9) Productivity has a long boom-bust cycle because innovation is lumpy. (10) Our productivity proxies suggest bean counters aren’t counting all the beans in services. (11) The freebie problem. (12) “Mr. Holmes” (+ +). (More for subscribers.)

Is the Soft Patch Over? (excerpt)

The soft patch may be over. The latest batch of economic indicators is certainly more upbeat than previous ones. Most importantly, I am impressed with May’s 0.6% m/m increase in our Earned Income Proxy (EIP), which is highly correlated with wages and salaries in the private sector. It’s also highly correlated with retail sales excluding gasoline, though the two series have diverged so far this year, with the latter lagging the former.

A sharp rebound in May retail sales would confirm that the soft patch is over. May auto sales did rise to 17.8 million units (saar), the highest since July 2005. We still have some concerns that rapidly rising tenant rent and out-of-pocket health care costs may be offsetting some of the positive impact of our rising EIP. May’s retail sales will be reported this Thursday. An upbeat housing-related indicator was April’s Pending Home Sales Index, which rose to the highest level since May 2006. It tends to be a good leading indicator for existing home sales.

And, of course, there was plenty of good news in Friday’s employment report. Most impressively, full-time household employment rose by 630,000 during May, having risen 2.6 million over the past 12 months. While wage gains remain relatively subdued around 2% on a y/y basis, the latest three-month changes are mostly around 3%, on average, at an annual rate.

Today's Morning Briefing: Peter Pan. (1) By the shores of Lake Winnipesaukee. (2) Seven strategists and economists with seven opinions. (3) Consensus vs. contrary scenarios. (4) Kuroda says we can fly if we believe we can. (5) Japanese inflation close to zero again despite all the pixie dust. (6) Draghi plays Captain Hook. (7) Less deflation, more growth in Eurozone. (8) Dudley: On your mark, get set, wait. (9) Fed policy is market dependent too. (10) Is the US soft patch over? (More for subscribers.)

Yellen on the Wage Question (excerpt)

Fed Chair Janet Yellen has stressed the importance of wage inflation in influencing the FOMC’s decision to start raising interest rates. April’s average hourly earnings (AHE) for all workers rose just 0.1% m/m and 2.2% y/y. She has said that she would like to see 3%-4% wage gains, or be reasonably confident that they are heading in that direction. The three-month change in this measure of wages settled down to 1.8% (saar) during April from 3.6% during March. Nothing to get Yellen too excited, which seemed to get the stock market very excited on Friday.

However, Q1’s Employment Cost Index (ECI) for wages and salaries in the private sector--a more comprehensive measure of wages than the AHE rose 2.7% y/y, the highest since Q3-2008. The Phillips Curve, which posits an inverse relationship between wage inflation and the unemployment rate, is actually working much better with the ECI than the AHE measure of wages, especially compared to the short-term unemployment rate. (See Phillips Curve.)

Yellen is a big believer in the Phillips Curve. She said so in an important 3/27 speech: “A substantial body of theory, informed by considerable historical evidence, suggests that inflation will eventually begin to rise as resource utilization continues to tighten. It is largely for this reason that a significant pickup in incoming readings on core inflation will not [her emphasis] be a precondition for me to judge that an initial increase in the federal funds rate would be warranted. With respect to wages, I anticipate that real wage gains for American workers are likely to pick up to a rate more in line with trend labor productivity growth as employment settles in at its maximum sustainable level. We could see nominal wage growth eventually running notably higher than the current roughly 2 percent pace.” In a footnote, she cited four studies for “recent evidence on the relationship between labor market slack and wages.”

Today's Morning Briefing: Goldilocks' Godmother. (1) Janet & Hamlet: To lift or not to lift? That is the question. (2) Janet & Christine: High and mighty say stocks are mighty high. (3) Yellen’s dashboard shows labor market is cruising. (4) Phillips Curve may be starting to work, pointing to bigger wage gains. (5) April retail sales may settle soft-patch question. (6) Yellen’s latest assessment of stock valuation: It’s high. (7) Addictive fairy dust. (8) Another relief rally after latest feared outcomes turn out to be nonevents. (9) On the verge of a melt-up? (10) Energy, Materials, and Financials join the rally parade. (11) ECI vs. AHE. (More for subscribers.)

Will Robots Bend the Phillips Curve? (excerpt)

There’s an important debate about wage inflation. The inverse relationship between wage inflation and the unemployment rate is known as the "Phillips Curve." It makes sense that wage inflation would rise or fall depending on whether the unemployment rate was relatively low or high. However, I have been arguing that the Phillips Curve might not work as well given increasing globalization, innovation, and competition.

In his Barron’s column this week, Gene Epstein argues that wage growth is about to take off. He bases this forecast on a version of the Phillips Curve model devised by Jason Benderly of Applied Global Macro Research. In addition to the level of the unemployment rate, this model includes the change in the jobless rate, labor productivity, and the after-tax profit margin.

I note that the unemployment rate remained at 5.5% during March, the lowest since May 2008, yet wage inflation remained subdued for all workers at 2.1%, while falling recently to 1.8% for production and nonsupervisory workers. On the other hand, as we noted last week, wage inflation over the past three months through March for all workers jumped to 3.9% (saar), the highest since December 2008. That might have reflected the one-shot impact of the widespread hike in the minimum wage at the start of the year. Or else, the Phillips Curve is starting to work, finally.

If it’s different this time, then robots might be one of the reasons. The 4/23 WSJ reported that in Oxnard, California, “A 14-arm, automated harvester recently wheeled through rows of strawberry plants here, illustrating an emerging solution to one of the produce industry’s most pressing problems: a shortfall of farmhands.” The 4/24 NYT reported, “Faced with an acute and worsening shortage of blue-collar workers, China is rushing to develop and deploy a wide variety of robots for use in thousands of factories.”

Today's Morning Briefing: Great Debates. (1) The link between easy money and secular stagnation. (2) Summers vs Rogoff. (3) Debt super-cycle. (4) Time heals all wounds. (5) Asia’s debt binge. (6) Glut of gluts. (7) Will China solve its debt problem with a stock bubble? (8) Lots of burdensome debt burdens in Japan, Eurozone, and China. (9) US corporations borrowing for financial engineering. (10) A cold spring following an icy winter. (11) Dallas slipping on oil. (12) Are robots bending the Phillips Curve? (13) Lots of debatable subjects including Fed, oil, dollar, Grexit, MENA, and the meaning of life. (More for subscribers.)

Inflation Warning (excerpt)

Last week, the 4/16 WSJ reported: “U.S. wages may be starting to pick up, a development that could help policy makers at the Federal Reserve feel more confident that sluggish U.S. inflation also will gain traction, Fed Vice Chairman Stanley Fischer said Thursday.” He said so on a panel discussion in Washington. That same morning, in a CNBC interview, he said the Fed knows the markets “look ahead somewhat, so I think--I hope--that they are taking into account that the Fed, at some point, is likely to raise the interest rate.” On timing, he said markets “can’t depend on the current situation continuing forever--or even probably--beyond the end of this year.”

He reiterated that “there are more signs every day” of mild wage increases. What is he looking at? Let’s have a look:

(1) Minimum wage. Anecdotally, the minimum wage was raised in 21 states at the start of the year. However, during March, average hourly earnings rose only 2.1% and 1.8% for all workers and for production and nonsupervisory workers.

(2) McDonald’s. On 4/15, fast-food cooks and cashiers demanding a $15 minimum wage walked off the job in 236 cities in what organizers called the largest mobilization of low-wage workers ever. On April 1, McDonald’s announced plans to give employees a 10% pay bump and some extra benefits. The raise will affect about 90,000 workers at a small fraction of McDonald’s stores. Employees at franchises, which make up the majority of the burger chain's locations, won't be affected.

(3) Walmart. At the start of April, Walmart raised its minimum starting wage to $9 an hour, 24% higher than the federal minimum. A 4/10 story on PBS NewsHour noted, “The company says that its wage increases will impact 500,000 workers, but the number who will see their wages rise from the federal minimum of $7.25 to $9 is much smaller. Only 5,000 of its 1.4 million workers actually make the minimum wage. And the minimum in most of the country, 29 states, is already considerably higher than the federal minimum. Seven states and the District of Columbia have minimums of $9 or higher. So the average pay raise for the affected Walmart workers will be far less than the 24% raise for the very small number currently earning the federal minimum.”

(4) Quit rate. The quit rate in retailing tends to be relatively high, especially among low-paid workers. Retailers are raising their wages to reduce their labor turnover costs.

(5) Q1 wages and prices. Average hourly earnings for all workers rose 3.9% (saar) during the first three months of the year, the highest since December 2008. That’s the kind of y/y increase that Fed officials have said would allow them to normalize monetary policy sooner and at a faster clip.

In addition, the core CPI inflation rate edged back up to 1.8% during March, closer to the Fed’s 2% target--which is really for the core PCED, which was 1.4% during February. The three-month annualized change in the core CPI through March was 2.3%, suggesting that the core PCED, which was 0.9% through February, might show a higher increase when March data are released on Thursday, April 30.

Today's Morning Briefing: The Twilight Zone. (1) Valuations on the border of the Irrational Zone. (2) Three fears hit market: Greek exit, China bubble, and inflation uptick. (3) Recapping stretched valuations. (4) Institutional investors remain skeptical. (5) Outperforming SMidCaps less exposed to dollar. (6) Shortage of bargains. (7) Buybacks = Corporate QE. (8) Corporate execs comparing earnings yield to borrowing rate when buying back shares. (9) Warning: Inflation may be warming. (More for subscribers.)

Redistributing Income to Reduce Inequality (excerpt)

Income equality is easy to achieve by making nearly everyone poor. That has been and continues to be the modus operandi of totalitarian regimes. Capitalist systems are often infested with corrupt cronies, but true capitalists tend to prosper when their customers have more income to spend.

Meanwhile, the income inequality debate continues to rage on today. Progressives claim that it has worsened in recent years. They typically show a chart of real median household income, which has declined 9% from a record high of $56,900 during 1999 to $51,900 during 2013. In addition, they show that the share of income going to the top 1% is at a record high.

I’ve previously noted that the degree of income inequality may be exaggerated by demographic changes. For example, the percentage of singles in the adult population (i.e., aged 16 years and older) increased to 50% during February, up from 47% and 44% 10 and 20 years ago. Households composed of a single person tend to have lower incomes than those of a married couple. Young singles tend to be just starting their careers. Older singles tend to be retired and living on their savings, dividends, interest income, and government support. As the Baby Boomers age and their longevity increases, they could significantly distort the extent of income inequality.

Which raises an interesting question about the income inequality debate: What are we arguing about? The median household income data so frequently used to show that standards of living are stagnating for most Americans do not include government support payments. Could it be that the Progressives are right about worsening income inequality, but are ignoring the fact that the problem continues to be fixed by the very government programs that they implemented during their New Deal and Great Society heydays?

Exhibit A is the fact that government benefits now account for 17% of personal income, up from 14% 10 years ago and 12% in 2000. Labor compensation (i.e., wages, salaries, and supplements) was down to 60.7% of National Income during Q4-2014 from its recent high of 66.2% during Q4-2008 and its record-high 67.9% during Q2-1980. However, total personal income continues to hover between 95% and 100% of National Income, as it has since the start of the 1980s. That’s all because of government support payments, which increasingly have been deficit financed.

The conclusion is that Progressives who claim that income inequality has worsened have to prove that this is so after government support payments have been made, not before. If they are still right, then they will undoubtedly continue to press for even more income redistribution. However, before they do so, they should prove that the existing redistribution programs are not the cause of worsening income inequality. Conservatives argue that government benefits erode the work ethic and thereby exacerbate income inequality. I agree with that view. The debate will continue.

Today's Morning Briefing: Running of the Bond Bulls. (1) Granada & Barcelona. (2) Alcazar & Alhambra. (3) Ruling class always lives well. (4) Income inequality now and then. (5) Income inequality before and after government support. (6) Progressives need to prove that redistributing income isn’t worsening income inequality. (7) Bond bulls worrying about Pamplona scenario. (8) Yellen and Draghi want to be reasonably confident of inflation’s rebound. (9) Focus on market-weight-rated S&P 500 Industrials. (More for subscribers.)