Productivity increases at 2.9 percent rate in the second quarter

WASHINGTON (AP) - The productivity of American workers rose at an annual rate of 2.9 percent in the spring, the slowest increase since late 2002, the government reported Tuesday.

The Labor Department said the increase in productivity, the output of workers for each hour worked, in the April-June quarter, followed a 3.7 percent rate of increase in the first quarter.

The 2.9 percent increase was the smallest gain since productivity rose at an annual rate of 1.6 percent increase in the fourth quarter of 2002. Analysts had been predicting an even bigger drop-off in productivity in the second quarter to around 2.3 percent, reflecting the fact that the economy slowed sharply in the second quarter.

Unit labor costs, which are being closely watched by the Federal Reserve for signs of inflationary pressures, were up at an annual rate of 1.9 percent in the second quarter, the biggest rise in two years, following a 0.3 percent advance in the first quarter.

Many analysts noted that even though unit labor costs accelerated in the second quarter, the rise for the past 12 months was still a tiny 0.2 percent, indicating that wage pressures remained almost non-existent.

"The fact that unit labor costs remained well-contained suggests that the inflation outlook will remain benign," said Merrill Lynch economist Ron Wexler.

On Wall Street, the Dow Jones industrial average was up 70 points in late morning trading as investors reacted with relief to a small drop in oil prices.

Productivity is the key determinant of living standards. If productivity is rising, it gives employees the room to raise workers' wages without having to boost the price of their products. That means that the wage gains do not translate into higher inflation and workers enjoy rising living standards as their fatter paychecks go farther.

The country suffered through two decades of weak productivity gains starting with the 1973 oil shock. But since the mid-1990s, productivity gains have accelerated as the country reaped the benefits of large investments in productivity enhancing equipment such as computers.

However, the huge productivity gains have had a downside in weak job growth as employers were able to boost production with existing employees and did not need to hire new workers.

Federal Reserve Chairman Alan Greenspan has been saying this year that productivity increases were likely to slow in coming months as employers exhausted their ability to boost output with existing employees and would have to begin hiring more workers.

A major factor restraining the increase in non-farm productivity in the second quarter as a sharp slowdown in overall production. The country's gross domestic product, the total output of goods and services, rose at an annual rate of just 3 percent in the second quarter, down from a 4.5 percent GDP growth rate in the first three months of the year.

After a period of solid gains in employment in the first five months of this year, employment growth has slowed sharply in the last two months. The Labor Department reported Friday that businesses added just 32,000 workers to their payrolls last month, far below the 200,000-plus gain that economists had been expecting.

The sharp slowdown in job gains is being cited by Democratic challenger John Kerry as evidence that President Bush's economic policies are not working.

The government later this week will release new figures on initial claims for jobless benefits, retail sales, wholesale prices and trade.