US Competitiveness and Charlie the Tuna

Charlie the Tuna was a figure in a Starkist commercial many years ago (circa 1961). Charlie confused tuna’s with good taste (culturally adept) with those that taste good. Anyway, we affectionately nicknamed one of our childhood friends Charlie the Tuna. Charlie is a regular reader of this blog and generally lambasts me about my negative attitude toward US manufacturing. Charlie is a devoted cheerleader for US manufacturing and he should have been proud when the US announced productivity figures this week.  More will be said about US productivity below.

But first, let’s discuss US competitiveness. While the “C-word” can probably mean different things to different people, we often associate national competitiveness with an ability of a given country’s products and services or its firms to duke-it-out with firms from other countries. China’s export success is often taken as evidence of that country’s increased competitiveness.  Persistent and growing trade deficits of the US are considered to be evidence of the opposite.

Competitiveness in the above sense can be affected by many things. For example, the US often argues that China unfairly depreciates its currency or gives unfair subsidies to its firms as a means to improve competitiveness. Of course, fundamental factors are also important, factors that relate to the ability of a nation’s firms to produce high quality and innovative goods at the lowest possible prices.  That is where the recent announcement of the Bureau of Labor Services (BLS.gov) comes in.  On May 5, 2011 a news release announced data for productivity and costs for Q1 2011. While this was ignored by most outlets that cater to normal people, Bloomberg had a story titled something like “Productivity advanced by a measly 1.6% while business costs increased in the first quarter of 2011.” Even that headline failed to be as interesting as other stories nearby like “Babies who stop bottle feeding at one year are prone to be really fat” and “Physicists at the University of Alabama uncovered a bio-marker for athlete’s foot.”

If you actually read the government press release you understand why this critical information essentially gets blown in a black hole in some distant universe.  I read it and found myself quickly adrift with sea nymphs and cheerleaders.  After my nap I decided to go to the BLS website and see if I could discern a story from the actual data and sure enough it was all there. There is a story and it basically says a couple of things. First, Charlie the Tuna should be very proud since manufacturing is clearly leading us out of the wilderness. Second, the numbers suggest that the government has to STOP stimulating the economy. If there is any way to improve US competitiveness, it is by keeping inflation low and government debt in control. Since neither of these points is obvious on their own merits, let me try to convince you they are true.

The first bit of data in the release is something called UNIT LABOR COSTS. This is like naming your kid Ora. No kid wants to be called Ora. No economic variable wants to be called Unit Labor Costs. So let’s just rename it ULC. ULC is a measure of how much labor cost is changing in a typical unit of output.  If ULC change is zero, it means that labor involved with producing, e.g. bagels, are not causing change in the cost of producing one bagel.  If ULC for bagels is increasing by say 10% that tells us that labor costs are responsible for a 10% increase in costs of making a bagel. Companies become better competitors when their ULC is slowing – or better yet, decreasing. So ULC is an important aspect of a company or a country’s competitiveness.

After increasing at a rate of about 1.8% per year from 2003 to 2007 ULC of the non-farm business sector increased by only about 0.3% in 2008 and 2009 and then declined by about 0.2% afterward. The experience of manufacturing companies was very different. During the strong growth period from 2003 to 2007, ULC grew by only about 0.2% per year. During the recession ULC grew at an annual rate of almost 5% only to decline again in the recovery quarters to -3.6% per year. While the experiences were different the outcome for the last seven quarters is the same – manufacturing and other non-farm businesses have seen ULC decline.

One conclusion is that the US is experiencing improved business competitiveness in the recovery period – and this improvement has been especially strong in the manufacturing sectors. What explains this? The most straightforward answer comes from the definition or calculation of ULC. There are two key factors that determine changes in ULC: labor compensation per hour and labor productivity per hour. Recall that ULC has to do with labor costs embodied in the average unit of output. So clearly, a change in labor compensation per hour will impact ULC. If the Bagel Workers of America obtain a 10% per hour wage increase and if they work the same number of hours you can see how this will raise business costs and ULC.

But how much ULC increases depends on productivity change – or what we call output per labor hour. Let’s suppose workers get 10% more wages per hour but also are able to produce 10% more output per hour? Total costs would rise – but the costs per unit of output would not. So now you see that both output per hour and wages per hour must be brought together to understand ULC.  And we learn the following:

o   Wages per hour growing faster than output per hour --- ULC rises
o   Wages per hour growing slower than output per hour --- ULC falls
o   Wages per hour growing the same as output per hour --- ULC constant

In the expansion years from 2003 to 2007, manufacturing compensation per hour was rising at about 3.5% per year. But output per hour was growing by 3.7% per year so ULC hardly grew at all.

When the recession hit in 2008 manufacturing compensation actually increased to an average annual rate of about 4.8% per. Productivity declined at a rate of -0.4% per year and therefore ULC was rising at about 5.2% per year.  While rising wages contributed to ULC rising it was the decline in output per hour that really hurt competitiveness.

Coming out of the recession in 2010 (Technically the recovery begins in the third quarter of 2009) and early 2011 manufacturing productivity recovered dramatically averaging about 6% per year. Wages per hour have slowed to a rate of a little over 2%. Thus coming out of the recession ULC is falling at a rate of about -3.6%. Of course, this is exactly what you want to see if the US is going to grow through exports. Moreover, this enhanced competitiveness gives firms the ability to provide more goods at low prices within the US – improving both national output and inflation.

The following table summarizes the key numbers discussed above.

                                                Average Annual Percentage Change

                                                Manufacturing companies

                    Compensation       Output                     ULC

                          per hour               per hour

2003 to 2007       3.5                      3.7                        -0.2

2008 to 2009       4.8                     -0.4                         5.2

2010 to 2011       2.5                      6.1                        -3.6

So what does this mean for policy? First, the usual business cycle factors will mean that compensation will probably soon increase by more than 2.5% per year and productivity will not continue rising at 6% per year. Thus ULC will probably increase.  The role of policy, then, is to slow this normal cyclical process as much as possible in two ways: (1) provide an economic climate such that wage growth does not quickly rise and (2) ensure that output per hour does not quickly decrease.

Here is where the stimulus and national debt come in. Monetary and fiscal stimulus raises inflation expectations. The Treasury and the Fed keep reminding us that inflation is subdued. But it won’t be forever. Signs of inflation are around us everywhere. If we want competitiveness and manageable ULC, then we have to effectively and credibly convey a strong disdain for inflation. If workers do not believe that stimulus will be removed in a timely manner then they will quickly and decisively pursue faster wage growth.  I buttress this forecast by looking at the real value of hourly compensation. Since 2002 the buying power of the hourly compensation in manufacturing companies has grown by less than 1% per year. While manufacturing workers during those years got hourly wage increases – they were barely enough to meet inflation. They are more than ready to make up for lost time.

But wages and inflation are only part of the story. The rest concerns productivity or output per hour. To maintain competitiveness, US firms must continue to invest in new equipment, structures, training, etc. To do that they need abundant and well priced capital. With government finance sucking up more money than US households can supply from their meager savings, this reduces the pool of available resources and significantly raises interest rates and the cost of capital. Any further indications that the US will not be able to pay its obligations will lead to a hasty departure of foreign funds and even higher costs of borrowing and/or raising capital.

Quick progress to reduce deficits and national debt will go a long way to improving productivity, the cost of labor, ULC, and US competitiveness. You would think that our goofs in government would come to understand this and stop playing with ideological bombs and class warfare.  The below chart shows (found at (http://research.stlouisfed.org/fredgraph.png?g=pj ) how important manufacturing ULC is to the health of the US economy. Notice how significant upward trends in ULC led to recessions after 1990 and 2000. While ULC was well-behaved before the last recession we all know the important role of finance in that one. But also notice that the recent recession has left us with historically high ULC. Despite recent improvement it is clear that ULC has a long way to go before it reaches more normal levels. Until then our competitiveness AND our national economic growth are in jeopardy.

Note – if you cannot see the below graph properly, please try the above link.