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For example, John, our hard working employee contributes to his own efforts 20 units of product per hour and he receives $40 per hour in compensation. Dividing his compensation by units per hour produced results in $2.00 per unit. This is the labor cost of each unit, assuming that John is the total labor for each unit. If John's productivity rose by 10% to 22 units per hour and his total compensation remained the same, the unit labor cost would fall to $1.82 per unit (40/22=1.82). John's company is better off since they are producing more units per unit of labor, so they can either make more money, i.e. profits grow or they can lower prices and hopefully sell more product. This increase in productivity could be caused by more and better training for John, use of new equipment to help him produce more, or maybe John has more experience on the job. Or some of John's fellow employees could have been laid off through a restructuring. Whatever the reason productivity rose and unit labor costs fell. On the other hand, let's say John received a 10% raise, increasing his total compensation to $44.00 per hour. In addition he did not increase his productivity, producing 20 units per hour. Now the unit labor costs are $2.20 per hour (44/20=2.20). While John is better off, the company must absorb his increased compensation. In fact John could be at risk of losing his job if the company cannot find a way to either increase prices or improve productivity to offset the rise in compensation. As long as the percentage increase in labor productivity is greater than the increase in labor compensation, unit labor costs fall. This has been our situation for the last several years. As a result the Federal Reserve has been able to keep interest rates low and help stimulate economic growth. When the percent increase in labor compensation exceeds the percent increase in labor productivity, unit labor costs rise. Percentage increases in unit labor costs that are greater than percentage increases in productivity are a major cause of inflation. This is an important point of interest for the Fed to consider when they next decide whether to change the discount rate on September 20, 2006. This brings me to the chart below. It is from the Bureau of Labor Statistics as of September 6, 2006 for data ending the 2nd Quarter 2006. The key point to note is that unit Labor costs are substantially higher than Output/hour (productivity). Several economist equated the large rise in labor costs to the large number of stock options and bonuses. I cannot find any indication if this true. To me it does not matter, it still is compensation and we might be seeing the first signs higher inflation due to higher labor costs.
© 2006
Hans Wagner As a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market. Feel free to visit the site at http://www.tradingonlinemarkets.com/ CONTACT
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