Productivity up strongly while labor costs drop

WASHINGTON - The work force was more efficient last year with productivity rising at the fastest pace in eight years. Labor costs fell for a second straight year, something that hasn't happened in nearly five decades.

Productivity, the amount of output per hour of work, rose a strong 3.6 percent in 2010 after a 3.5 percent gain in 2009, the Labor Department reported Thursday. Both years represented the best showing since 2002. Labor costs dropped 1.5 percent last year after a 1.6 percent decline in 2009.

But economists say the two-year surge in productivity is coming to an end as companies exhaust their ability to squeeze more output out of depleted work forces. They look for more hiring in 2011 which will help boost incomes.

Consecutive annual declines in labor costs have not occurred since 1962 and 1963 and underscored the pressure that workers' wages have come under during a deep recession which saw 8.4 million jobs disappear.

The big jump in productivity in the past year years represented the strongest gains since a 4.6 percent jump in 2002, a rise that was the best showing in more than a half century.

For the fourth quarter, productivity rose at an annual rate of 2.6 percent, slightly better than the 2.4 percent gain in the third quarter while labor costs fell at an annual rate of 0.6 percent after a 0.1 percent drop in the third quarter.

Analysts believe that the big gains in productivity of the past two years will come to an end in 2011 with some analysts thinking that productivity could slow to modest gains of 1 percent for a brief period before returning to more normal rates of around 2 percent to 2.5 percent.

Gains of that magnitude would be in line with the long-run trend for productivity which has averaged 2.2 percent growth for the past six decades.

Normally, a slowdown in productivity would be considered bad for the economy. But with unemployment at 9.4 percent and companies enjoying healthy profits, it could signal more hiring is on the way.

The increased hiring would give households more income to boost consumer spending. That is considered crucial to mount a sustained economic recovery.

During the recession, companies slashed their work forces as demand plunged. Productivity surged as companies relied on fewer workers to turn out products.

The Federal Reserve watches productivity carefully because increases allow companies to pay their workers more due to their increased output without being forced to boost the price of their products, which can cause inflation.

But with inflation pressures outside of energy nonexistent at the moment, the Fed is not concerned about a temporary slowdown in productivity. As long as unemployment remains elevated, workers will not have the bargaining power to push wages up to levels that would raise inflation concerns.