Productivity is moderating but still high by historical standards
Nonfarm business productivity grew at a 2.4 percent rate in the final quarter of 2000, less than the 3 percent pace posted in the third quarter and slower than the average rate of 4.2 percent for the first half of 2000. Given the slowdown in both real GDP and employment growth, it isn't surprising that the rate of productivity gains would moderate. Moreover, productivity gains tend to be most robust in the manufacturing sector, where activity waned during the second half of 2000. Despite the anemic pace of production and new orders in the fourth quarter, manufacturing productivity did manage to record a 4.8 percent gain. But this compares with a 6.5 percent rate of growth in the second and third quarters of 2000 and a whopping 8.3 percent rate in the first quarter of the year.

Since quarterly productivity changes are tied to changes in GDP and employment, it is more useful to gauge long-term productivity trends by making yearly comparisons. The trend is not all that different on a year-over-year basis. Productivity growth peaked in the second quarter of 2000 and moderated in the second half of the year. Yet, even with slower growth, the 3.4 percent pace was still a better showing than much of the middle 1990s!

Unit labor costs did accelerate in both the third and fourth quarters, increasing at a 3.2 percent and 4.1 percent rate, respectively. Typically, unit labor costs are inversely related to productivity. Thus, slower productivity gains are often accompanied by faster increases in unit labor costs. The fourth quarter increase doesn't appear as ominous on a year-over-year basis even though it is the largest rise since the second quarter of 1999.

While labor costs accelerated in the second half, non-labor costs actually moderated. Unit non-labor costs decreased in both the second and third quarters. Non-labor costs include profits, capital consumption allowances, interest, rental income and indirect taxes. It isn't unusual to see unit labor costs and unit non-labor costs move in opposite directions. But this helps to hold down total employer costs.

Market players have monitored productivity much more closely in the past few years than they have historically. Productivity has always been the missing link between higher wages and potential inflation. As long as employees produce more efficiently, higher wages are not passed on to consumers in the form of higher prices for goods and services. Fed Chairman Greenspan has been particularly vigilant on productivity growth in this expansion - which has allowed the jobless rate to head into lower territory without wage inflation and a rapid run-up in interest rates through Fed tightening. Some analysts believe the Fed did indeed tighten monetary policy too much a year ago, and therefore has caused the current slowdown. That is certainly possible. However, without the rapid productivity gains, there is no way that a previous Fed board would have allowed the unemployment rate to fall below 5 ½ percent -- they would have feared inflationary pressures.

Consumer credit drops
The Federal Reserve Board reported that consumer installment credit increased a mere $3 billion in December, the smallest monthly gain in 15 months. These figures tend to be revised quite significantly, but the slower pace of credit expansion was largely due to the plunge in auto sales during the month. Moreover, retail sales were on the sluggish side for the holiday season.

The debt-to-income ratio remained unchanged in December at 21.5 percent. This ratio has been steadily increasing during the years and stands at an all time high. There is no question that the convenience of using credit cards and special frequent flyer plans has caused consumers to use credit cards more readily. But this has been factored in the equation for a long time. Consumers simply are using credit more readily. This may not have been a problem in a period of accelerating stock prices. But a bear market makes it tougher to sell stocks in case liquidity is needed. Moreover, the personal savings rate is negative - not leaving much of a cushion for consumers in this moderating economy.

Data miscellany
It was a slow week with respect to economic indicators. In addition to the fourth quarter 2000 productivity data and December consumer credit, market players were also given a hint on the labor market and the non-manufacturing economy. The Challenger job-cut report surged in February. In just two months of 2001, layoff announcements were equal to 40 percent of the total announcements recorded for 1998 as a whole! It is important to keep in mind that the Challenger report just adds up layoff announcements and does not distinguish between short and long-term plans. Thus, a portion of the February layoff figure is attributable to Chrysler downsizing over the next several years. It doesn't mean that all the workers will be laid off tomorrow. But the regional and industry distribution does suggest that layoffs are up from year ago levels.

The non-manufacturing NAPM survey also showed more moderate economic activity. The index for business activity - which is akin to the regular NAPM survey component for production - fell to 50.1 in January from a level of 61.1 in December. That is a big drop! Moreover, the monthly change is more meaningful given that the NAPM organization finally has enough historical data on this series to adjust it for seasonal variation. Until last month, the figures were only available unadjusted.