## Friday, January 17, 2014

### Unit Monetary Interest Cost

First of three in a series

An old post opens with a definition of Unit Labor Cost:

An important measure of productivity calculated by dividing total labor compensation (including benefits) by real output. An increase in unit labor costs will result in a reduction in profitability unless a firm can pass along higher labor costs to its customers. Economists view increases in unit labor costs as an important indicator of potential inflation.

An actual cost -- ie, not an inflation-adjusted cost -- is divided by the inflation-adjusted measure of output. That division skews the resulting number upward along a path comparable to the path of rising prices. Economists practice this sort of self-deception all the time. Let's go along with it this time.

Here's Unit Labor Cost (ULC) for Nonfarm Business:

 Graph #1: Unit Labor Cost
ULC goes up, along a path comparable to the path of prices. They tell you it means labor costs drive inflation. I say their arithmetic is corrupt.

The definition of ULC says "An increase in unit labor costs will result in a reduction in profitability unless a firm can pass along higher labor costs to its customers." Sure. But an increase in any cost will result in a reduction of profitability unless bla bla bla, just the same.

An increase in any cost. For example, an increase in interest cost would result in a reduction of profitability bla bla. Here's a picture of monetary interest paid by domestic US business. The "sector" is not exactly the same as the "nonfarm business sector" of Graph #1, but it's as close as I could find:

 Graph #2: Monetary Interest Paid: Domestic Business
The Unit Labor Cost is figured by dividing a particular cost (labor) by real output. I will figure the "Unit Monetary Interest Cost" (UMIC) similarly -- by dividing the Monetary Interest Paid number by real output:

 Graph #3: Unit Monetary Interest Cost
You should note the units shown in the left-hand border: Billions of dollars, divided by billions of inflation-adjusted dollars. Right away this should tell you the graph is garbage. Of course, it's the same units as the Unit Labor Cost graph. But on the ULC graph, that important piece of information is lost.

Oh, well.

So now we have a unit cost we can compare to the unit cost of labor. To make the comparison, I look at the unit cost of labor relative to the unit cost of monetary interest:

 Graph #4: Unit Labor Cost relative to Unit Monetary Interest Cost
Labor cost was high in the early years, relative to interest cost, high but falling. Since around 1980, labor cost has been on the low side. Basically, the ratio was falling all the while interest rates were rising. Then the ratio got stuck low while interest rates were falling, because business debt kept growing.

The economy was good when the ratio was high. Since the ratio went low, the economy sucks.

Oh, and the ratio fell all through the Great Inflation. Labor cost fell, relative to interest cost, all through the Great Inflation.

Do you still think labor cost is the cost that drives inflation?

#### 1 comment:

The Arthurian said...

As an afterthought... In the post, the ULC definition says: "An increase in unit labor costs will result in a reduction in profitability unless a firm can pass along higher labor costs to its customers."

If prices go up enough to cover increased labor costs, then maybe nobody really gained by their wage increases, but nobody lost out either.

On the other hand, if prices go up enough to cover increased interest costs, wage-earners fall behind. Only the interest-earners' income keeps up with prices.

However, if interest-earners tend to be people who save -- a foregone conclusion, in my view -- then their extra interest income is likely to remain in savings. Based on their non-interest earnings, then, even interest-earners tend to fall behind.