It's the Economy, Stupid

The Labor Department today reported that business productivity surged to a revised 4.3 percent annual rate in the second quarter of the year. That's impressive. It's nearly double the 2.2 gain previously reported. It's also well ahead of forecasts. So why did stocks tumble and the Dow Jones Industrial Average fall more than 300 points?

Because it's finally dawning on investors that Americans don't have the purchasing power to keep the economy going. A separate report today from the Department shows a steadily weakening labor market. The number of U.S. workers filing new claims for jobless benefits jumped by 15,000 last week, to a seasonally-adjusted 444,000. That's much higher than anticipated. We'll know tomorrow whether employers continued to shed jobs in August, as they've done in the prior seven months.

Remember, productivity measures hourly output per worker. When firms lay off their workers or cut the number of hours they work, the firms often get more output per hour from them. This is often because employees are pushed harder to generate more output in fewer hours -- understanding that if they don't, they'll be the next ones on the chopping block. Or because each who remains is overseeing more machinery than before. (This may result in lower-quality products and services, but the productivity figures don't measure quality of output.)

Higher productivity keeps inflation in check. When companies can produce more stuff with fewer workers, their unit costs drop. And they face even less pressure to raise wages -- even in the face of rising costs of living -- because average employees have virtually no bargaining power. This also helps boost corporate profits.

But this also means less purchasing power by consumers whose paychecks are getting even smaller and jobs even less stable, and who have reached the end of their lines of credit because the housing bubble has burst. The result? Employers can't sell as much as before, so they reduce their payrolls by cutting hours and laying off more workers.

Retailers are the canaries in this mine. Their sales are sharply down. (Today Nordstrom and other retailers posted big disappointments for August sales.)

Unless or until America's broad middle class has more money in its pockets -- because we get a more progressive tax system, because unions become more powerful and push prevailing wages upward, because employers finally understand what Henry Ford understood a century ago (unless workers have enough money to buy the products they're making, the products won't sell) -- this downturn is likely to last a long time.