Economic Fundamentals Improve

 | Dec 16, 2011 | 4:00 PM EST
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Adding to the string of improved optimism by businesses, two reports released yesterday, the New York Fed's Empire State Manufacturing Survey and the Philadelphia Fed's Business Outlook Survey, showed improved economic fundamentals, pointing to continued, modest growth. Both surveys showed acceleration in activity from prior months, and, importantly, the forward-looking metrics were quite robust.

Reading between the lines of the prices received and input costs metrics, however, either margins may still be constrained or companies may be trying to offset those cost increases through improved productivity.

Because both surveys showed employee benefit costs as the largest component of projected cost increases, it appears that these manufacturers may resort to productivity enhancements to a greater degree rather than adding staff in order to boost production. The metrics point to increased hiring, but with less labor utilization than the output gains might suggest.

The general business conditions index in the Empire State Survey rose nine points to 9.5, after having been near, or below, zero since June; this was the first month with a measurable gain since May. Nearly one-third of respondents reported that conditions were better, but about one-fifth reported they were worse. New orders climbed to 5.1 from -2.07.

However, the big news was in the future conditions six months from now. The future general business conditions index rose 13 points to 52.3, but the future new orders index surged 19 points to 54.7. The metric for expected level of employees moved up 10 points to 24.4, and the average workweek also climbed. That said, despite the fact that 64% of companies expected more new orders (vs. 9% that expected fewer), a more modest 38% expect to add staff, while 14% plan to reduce headcount. And despite this net 55% of respondents expecting more new orders, only 22% plan to increase the average employee workweek.

The Philly Fed Survey showed similar results. The broad measure of business activity climbed to 10.3 from 3.6, and the percentage of firms that reported increased activity (25%) exceeded those that reported decreased activity (15%) by a comfortable margin. Twenty percent reported an increase in employment, while 10% reported a decrease. New orders advanced to 9.7 from 1.3.

As was the case with the Empire State Survey, considerable strength appeared in the forward-looking metrics of the Philly Fed Survey, with general business activity reaching 44.1, a 2.9 point improvement from the November level. The employment metric, however, didn't quite rebound as sharply, as this number fell to 12.9 from 25.4 for the forward-looking component. Again, even though 54% of companies expect higher new orders (vs. 6% with fewer), only 24% of manufacturers in this region expect to add to their staff, while 11% plan to reduce employment levels. In other words, a net 48% expect higher new orders, but only a net 13% plan to add to staff, and only 7% plan to increase the employee workweek. This means that companies do, in fact, expect productivity gains to alleviate some need for human capital.

In both surveys, the aspect of employment not keeping up with output speaks to the fact that input prices are rising faster than the price increases that manufacturers are able to pass along to their customers. A special question in both surveys showed that of all the input costs, employee benefit costs have the largest expected price increases.

For example, in the Empire State survey, energy costs are expected to climb by 2.9% and other commodity prices by 3.9%, with overall input prices expected to advance 3.5%. But, employee benefit costs are projected to surge 6.1%. Similarly, the Philly Fed survey reports that respondents expect energy prices to edge up 1.8%, other raw materials to increase by 3.3%, but they expect health benefits to jump 7.3%.

These benefit costs have to be absorbed somewhere since companies are not expecting their own selling costs to increase in tandem with their input costs. The result: Companies are reluctant to hire, relative to what their anticipated output increases might suggest, or they will keep wage costs further under control. Thus, these manufacturers will likely offset higher benefit costs by not giving workers much in the way of pay increases or they will likely resort to further productivity-enhancing measures, so that they can rely less on an hour of human capital for a given level of output. We can see this in the fact that the number of employees and hours worked metrics are not rising as fast as the production metrics are. Also, wages are expected to rise by just 2.1%, according to the Philly Fed Survey and by 2.8%, as forecast in the Empire State Survey. Both of these projected wage increases are less than the overall cost increases.

Based on these surveys, one reason why employment on a broader, more national scope has not risen might be due to the rising employee benefit costs, which seem far above what employers can hope to recoup through more modest increases in selling prices. In essence, if health care costs can be controlled to some extent, might we see increased hiring?

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