RBC Financial economists say that productivity improvements should give businesses the boost they need to drive economic growth in the United States.

In the October issue of the Current Analysis, RBC economists observe that year-to-date, business profits before taxes remain 9% below year-ago levels, although they have begun to increase. The big question, according to RBC, is whether these gains are sustainable.

RBC says that it believes that profit gains are sustainable. For one thing, it believes that profits are being understated at this time. “When adjusting for non-cash items, cash flow growth appears much stronger than profit growth so far this year. Depreciation rates have accelerated due to the nature of the new capital stock added in recent years. When added back into pre-tax profits along with other non-cash items, the resulting cash flow measure suggests that profitability is running 9% above year-ago levels.”

It notes that cash flows are up because margins have been improving. Business margins have been growing because unit labour costs have been falling sharply while selling prices continue to increase, argues RBC.

It says that the U.S. economy is expected to remain in a state of excess capacity well into 2004, leaving little room for prices to go higher. But, “The outlook for costs is brighter than conventional wisdom would suggest at this time,” it insists. It says that estimates suggest that recent reductions in unit labour costs have come as much out of higher productivity growth as out of lower wages costs.

“Even with cost-cutting measures coming to an end next year alongside a more robust labour market and a higher wage bill, gains in productivity should prove sufficient to prevent unit labour costs from pushing above selling prices and keep profit growth positive. We expect profits before taxes to increase by 8% through 2003, following a gain of 14% through 2002 barring any sustained war related spike in the price of oil,” concludes RBC.