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Slow productivity growth could hurt the economy

The economy has been humming lately, with output and job growth accelerating, but future gains may be limited by a creaky engine: slow productivity growth.

Sluggish productivity already has narrowed the fourth-quarter earnings reported by large corporations in recent weeks and is likely to continue to constrain wage increases and economic growth, analysts say.

"It's a major problem," says Robert Atkinson, president of the Information Technology and Innovation Foundation.

Productivity, or output per labor hour, fell at a 1.8% annual rate in the fourth quarter and was up just 0.8% in 2014, the Labor Department reported earlier this month. That's well below the 2.2% average from 1947 to 2014.

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Productivity hasn't risen by more than 1% a year since growing about 3.3% in both 2009 and 2010. During that stretch, economic output rebounded after the Great Recession, but wary employers hired sparingly and squeezed more from existing workers.

In the short term, low productivity growth is a good thing for the labor market. With the production potential of each employee limited, businesses must hire more workers to meet growing demand. Monthly job gains averaged 260,000 in 2014, the strongest showing since 1999.

But anemic productivity squeezes the profit margins of employers as their earnings fail to keep pace with rising labor costs. Fourth-quarter operating margins for Standard & Poor's 500 companies are running at 8.9%, the lowest in two years, says Howard Silverblatt, S&P senior index analyst.

Goldman Sachs blames weak productivity growth, as well as other factors, such as a strong dollar.

Thin profit margins limit employers' ability to give raises. Barclays Capital economist Blerina Uruci estimates annual wage gains, which at 2% have barely kept up with inflation, will pick up to a 3% pace this year as falling unemployment forces firms to pay more to attract a smaller pool of workers. But, she adds, pay raises would average 4% if productivity growth were normal.

Weak productivity also hampers the economy, which can grow only by adding workers or increasing each worker's output, says Doug Handler, chief U.S. economist at IHS Global Insight. With Baby Boomers retiring and the unemployment rate at a near-normal 5.7%, productivity gains must shoulder a bigger share of the economic growth burden, he says.

Ultimately, a less productive, slower-growing economy means less hiring.

Atkinson and Handler largely attribute the listless productivity advances to inadequate business investment. Annual business spending on equipment and software has averaged 5.4% to 5.8% of gross domestic product since 2010, below the pre-recession level of 6.1% in 2007, according to IHS and the Commerce Department.

Atkinson says corporate executives have become fixated on short-term profits that determine their annual bonuses. "We have turned into a society that is myopically focused on the short term," he says.

A report last week by the San Francisco Federal Reserve places more blame on a dearth of innovation since significant strides in information technology boosted efficiency in industries such as retail from the mid-1990s through 2003. Annual productivity growth exceeded 3% during that period.

"By the mid-2000's, the low-hanging fruit of IT-based innovation had been plucked," say report authors John Fernald and Bing Wang.

Atkinson points to federal policy decisions, saying Congress has severely cut back investment in research and development.

Handler expects productivity growth to rebound somewhat to 1.5% this year as the 3.1 million workers hired in 2014 become more proficient at their jobs.