Wages, Benefits Grew in Spring
Inflation Fears Rise With Labor Costs

By Nell Henderson
Washington Post Staff Writer
Thursday, September 7, 2006

Wages and benefits rose strongly in the spring, the government reported yesterday, providing a bit of good news for some workers -- and fresh concern about inflation.

The statistic known as labor compensation, which includes wages and employment benefits, rose at a robust 6.6 percent annual rate from April to June, the Labor Department said, revising its earlier, incomplete estimate of 5.4 percent growth.

For workers, the gain, significant as it may sound on first blush, barely exceeded surging prices for gasoline and many other items. After adjusting for inflation, compensation rose at a more modest 1.6 percent annual rate.

Modest or not, analysts who are paid to worry about inflation saw plenty of reason to do so yesterday, fretting that rising labor costs may squeeze corporate profits or prompt the Federal Reserve to raise interest rates to restrain price increases.

"We're seeing a labor market that is tighter and beginning to manifest itself in higher wage inflation, which is probably going to get worse before it gets better," said one of the paid worriers, Nariman Behravesh, chief economist at Global Insight Inc., a financial analysis and forecasting firm. That outfit predicts the Fed will raise interest rates again this year, though not as soon as its next meeting Sept. 20.

Global Insight agrees with the Fed's forecast that inflation will fall next year, as slower economic growth makes it harder for businesses to raise prices. But Behravesh said that until then, "the dilemma . . . is how long can the Fed let inflation creep up and do nothing without the markets getting upset."

Investors in futures markets are betting that the Fed probably will not raise interest rates again this year and that it may even cut rates early next year as the cooling housing market saps economic growth.

That view was bolstered yesterday by the Fed's survey of regional economic conditions, which described slumping sales of cars and houses, and modest increases in consumer spending in August.

But the Fed survey also echoed the Labor Department's report, as some of the 12 Federal Reserve Bank districts reported "sharp wage increases or wage pressures" for workers in certain industries, such as information technology, trucking, retail, finance and health care. The Fed survey showed shortages of certain high-skilled workers.

For example, the Philadelphia Fed reported that in its district, "wages are generally reported to be rising slightly faster now than at this time last year, but salaries offered for positions that are difficult to fill have increased substantially." The survey summarizes business anecdotes without identifying companies by name. In the Philadelphia district, "firms in all industries continue to report increases in health-care costs," the report said.

The Fed left its benchmark short-term interest rate unchanged at 5.25 percent at its last meeting Aug. 8, taking a break after 17 consecutive increases over the past two years. The majority of policymakers at the table thought they might be done tightening credit, according to minutes of the meeting released last week.

The policymakers also saw inflation risks, the minutes showed, noting "a worrisome picture" of rising labor costs and slowing productivity -- the economy's output of goods and services per hour worked.

The Labor Department report yesterday updated those figures to show bigger jumps this year in labor costs, which account for an average of two-thirds of business costs and can be a key driver of inflation. "Unit labor costs," or compensation per unit of output, rose at a rapid 4.9 percent annual rate April through June after soaring at a 9 percent pace in the first three months of the year -- the fastest quarterly increase in nearly six years. Those increases were revised up from earlier estimates of 4.2 percent for the second quarter and 2.5 percent for the first quarter.

Some of those gains, particularly in the first quarter, probably took the form of one-time bonuses and other profit-linked pay to highly skilled, upper-income workers, economists said. But the breadth "suggests stronger inflation pressure," economists at Goldman Sachs Group Inc. said in a note to clients.

The Labor Department also said productivity grew at a modest 1.6 percent annual rate from April to June. That was better than its earlier estimate of a 1.1 percent pace but still a sharp slowdown from the 4.3 percent pace in the first quarter.

Faster productivity growth means businesses can raise wages and maintain profit margins without raising prices. Slower productivity growth means businesses can pay more only if they accept smaller profits or raise prices.

Former Fed chairman Alan Greenspan recognized in the mid-1990s that U.S. productivity was picking up as businesses boosted their efficiency through the use of computers, telecommunications and better methods of managing their supply chains. With productivity growing at an average 2.5 percent a year from 1995 to 2000, almost double the pace of the 1970s and 1980s, the Fed could let the economy grow faster and let unemployment drop lower than most economic models had predicted without fueling inflation.

Productivity growth even accelerated during the 2001 recession and the initially sluggish recovery that followed, again upending the models, growing at an average 3.5 percent a year from 2000 through 2003.

Fed Chairman Ben S. Bernanke, who succeeded Greenspan in February, said in a speech last week that "a case can be made" that the strong productivity growth since 1995 "is likely to continue for some time."

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