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Strategies & Market Trends : Graham and Doddsville -- Value Investing In The New Era -- Ignore unavailable to you. Want to Upgrade?

To: porcupine --''''> who wrote (297)	5/12/1998 7:07:00 PM
From: porcupine --''''>	Read Replies (2) \| Respond to of 1722

Stephen Roach on Rising Labor Costs: US: Cost Pressures Are Building -- Stephen Roach (from London) The cyclical dynamic of rising labor costs has taken a new and important twist in the spring of 1998. Two key factors are now at work -- the first being the time-worn response of the wage cycle to the classic forces of supply and demand in a fully employed labor market. This is the essence of the so-called short-term Phillips curve -- the widely scorned NAIRU (non-accelerating inflation rate of unemployment) theory. Far be it from me to throw cold water on the euphoria of the moment, but this theory is very much intact. No, this macro stuff is not physics, and we never know with great precision what the magical NAIRU threshold is -- whether it's an unemployment rate of 5.5% (the academics) or 5% (the number recently making the rounds in some Washington policy shops). But one thing is for certain, the 4.3% unemployment rate that was recorded in April -- the lowest level in 28 years -- has blown through even the most optimistic assessments of the NAIRU threshold. Ultimately, the wage cycle is the ultimate arbiter of the NAIRU theory. And just as this framework would predict, wage inflation is now on the rise. As measured on a monthly basis, average hourly earnings are now running 4.4% above the year-earlier rate. That's not only a cycle high but, in fact, the swiftest increase since 1983. Moreover the monthly wage data confirm the trends of acceleration indicated in the previously released Employment Cost Index, which showed "core" wage inflation (private industry workers less the volatile, commissioned-based sales occupations) rising at a 4.0% pace in the year ending 1Q98, a distinct pick-up from the 3.1% pace of a year earlier. Like it or not, the timeworn analytics of the NAIRU-based old paradigm theory are alive and well. At the same time, a second piece of the rising labor cost equation is beginning to emerge -- a distinct downshift in productivity growth following the impressive 2% surge in 1996-97. Productivity in the nonfarm business sector eked out an anemic 0.2% increase in 1Q98, marking a second consecutive quarter of deceleration from the heady gains of nearly 3% recorded in the two middle quarters of 1997. I have long argued that the apparent productivity surge of 1996-97 was nothing more than a temporary catch-up from the nearly stagnant pace recorded over 1993-95 interval; after all, the five-year average (1993-97) is +0.8%, virtually identical with the sluggish 1% trend of the late 1980s. And now, as the US labor market pierces its full-employment threshold, productivity gains are, indeed, turning out to be much harder to come by. That should not be so surprising. After all, most of the well-trained, experienced, and highly motivated workers are already on the job; incremental hiring from here on out will draw increasingly less efficient workers into the job pool, consistent with the late-cycle slowdown in productivity growth that invariably occurs once the US economy hits full employment. With productivity gains beginning to revert to the sluggish 1% trend that has prevailed since the mid-1970s, gone is the potential for any efficiency dividend that might have otherwise offset an upturn in the wage cycle. Significantly, with wage pressures now actually accelerating, it would have actually taken a pick-up in productivity growth to at least 3% to keep overall labor cost pressures in check. Instead, productivity growth is going the other way, decelerating at precisely the moment when wage costs are accelerating. The net result is an ominous upturn in unit labor costs, which have now risen at a 3.8% average annual rate over the past two quarters; that represents a distinct breakout from the subdued trajectory of just 2% that has prevailed over the 1994-97 period. I continue to believe that a transition from the well contained labor cost profile of the past four years to a more cyclical cost outcome over the 1998-99 interval represents a very important change in the macro climate of the US economy. Rising labor costs are simply too important to disappear into a vacuum -- they must show up in the form of either accelerating inflation and/or shrinking profit margins. I maintain my view that it will be a little of both. And I also believe that the Fed will respond to this increasingly ominous cyclical dynamic. In short, a rising labor cost profile for the US economy challenges much of the unbridled optimism that is currently embedded in financial markets with respect to earnings, inflation, and Fed policy. Barring a new upheaval in Asia -- or another bolt out of the "blue" -- the long-awaited test of the phenomenal asset appreciation of the 1990s is close at hand.