Some Good Economic News: More Growth Ahead In 2007

Corporate profitability remains solid, but slowing productivity and rising costs could dampen future prospects, according to analysis from The Conference Board.

With the current economic pattern expanding again for the sixth year and inflation seemingly under control, the U.S. economy will continue to grow through 2007, according to Gail D. Fosler, executive vice president and chief economist of The Conference Board. 

"The U.S. economy seems to have shaken off the burdens of cyclical dynamics," notes Fosler. Her analysis appears in StraightTalk, The Conference Board's newsletter.

Corporate profits, which have risen faster in this business cycle than in any other post-war cycle, provide valuable clues about the future of the U.S. economy and the corporate sector. Corporate profitability is also a key long-lead indicator of possible recession risks.

Fosler expects corporate profitability to peak this year, and that overall profit gains should remain solid for the foreseeable future.

"But the forces driving corporate profitability will likely become more adverse as we get further into 2007," says Fosler. "Slowing productivity and rising costs do not bode well for the future."

Many of the companies that have enjoyed lower costs during the early years of this decade have recently had to offset higher costs through higher prices – a tactic that is in direct conflict with the Federal Reserve Board's inflation mandate. Additionally, the moderation in growth is likely to set off a period for jockeying for profitability within the value chain.

Productivity is an important tool for keeping costs down because when it slows, costs tend to rise. Unit labor cost restraint was an important source of profitability for manufacturing and the total economy from 2001 to 2004.

But it is not the only player. As compensation costs rise and productivity gains wane, job growth picks up. This can put upward pressure on compensation when the unemployment rate is low, according to the analysis.

Total compensation, as measured by the National Income accounts, is rising at a 6 percent annual rate. Although productivity and compensation tracked each other closely in the early years of this decade, compensation has recently started outpacing productivity.

Companies have been able to offset the greater cost with higher prices, and margins appear to have stabilized or even peaked for this cycle. The tensions created by trying to cover rising costs with higher prices have put businesses and the Fed on a collision course that suggests higher interest rates and lower profits lie ahead, the analysis concludes.

More in Supply Chain