Data Reflect Fragile State of Economy

A series of economic reports released Tuesday, including one showing the first drop in worker productivity in six years, indicated that the U.S. economy remains fragile despite recent speculation that the worst had passed.

In the most closely watched report, the Labor Department said productivity declined at a 1.2% annual rate in the first quarter, the first drop since early 1995 and a weaker showing than the 0.1% decline that previously was estimated. Productivity measures how much employees produce for every hour they work.

Separately, the Commerce Department said factory orders declined 3% in April compared with March, further evidence that the manufacturing sector is suffering through its own recession.

And a report by a business group showed that the services sector, whose strength has helped balance the falloff in manufacturing, contracted for a third straight month.

“[The reports] are clearly showing a struggling economy,” said Gary Schlossberg, senior economist at Wells Capital Management in San Francisco. “[The economy] is strong enough to keep us out of recession, so far at least. But it’s not enough to prevent further declines in employment.”

However, many economists were upbeat, saying the Federal Reserve’s aggressive campaign to chop interest rates should boost the economy by the end of the year.

Economists downplayed the productivity report in particular, saying the measurement always drops when the economy is weak.

Moreover, the decline was expected given the recent downward revision to the nation’s first-quarter gross domestic product.

After initially estimating that GDP grew at a 2% clip in the quarter, the government said late last month that growth was only 1.3%. The two measurements are based on much of the same economic data.

Improved productivity was a key source of U.S. economic growth throughout the late-1990s, and is followed closely by Fed chief Alan Greenspan. An extended drop in productivity could stoke inflation, depress corporate profits and force businesses into heavy layoffs.

The biggest threat to productivity, many analysts agree, is the recent dramatic pullback in capital spending by U.S. businesses. Productivity surged in recent years as corporations poured money into technology equipment.

After growing at a 1.3% annual clip from 1973 to 1995, productivity grew at a 2.8% pace from 1995 to 2000.

The danger is that businesses bulked up too intensely, and may not boost spending after the economy recovers.

Some economists dismiss that notion, saying tech spending and productivity will rebound alongside the broad economy.

“Productivity will bounce back and remain very strong in the years ahead,” said Brian Wesbury, chief economist at Chicago-based investment firm Griffin, Kubik, Stephens & Thompson. “We have seen a long-term upward shift in productivity and any negative news will be temporary.”

Productivity slipped in the first quarter as businesses, reacting to the sudden drop in demand for their products, quickly reduced output. But they were much slower to cut employment rolls.

That dynamic caused unit labor costs to jump at a 6.3% pace in the first quarter, the largest gain since the fourth quarter of 1990.

Analysts said the most immediate economic concern may come from the report by the National Assn. of Purchasing Management. Its index of non-manufacturing activity slid to 46.6 in May from 47.1 in April. A reading below 50 shows the services sector is contracting.

Meanwhile, factory orders fell by $10.4 billion to $336.9 billion as orders for aircraft, motor vehicles and computers declined, according to the Commerce Department. Excluding the volatile transportation sector, orders slipped 1.7%.

New orders for durable goods, those lasting three years or more, fell 5%.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Worker Productivity

Percentage change from previous quarter at annual rate, seasonally adjusted:

1st Quarter: -1.2%

Source: Labor Department