US: Productivity and Costs

Thu Feb 05 07:30:00 CST 2015

Consensus Consensus Range Actual Previous Revised
Nonfarm productivity - Q/Q change - SAAR 0.2% -1.5% to 1.0% -1.8% 2.3% 3.7%
Unit labor costs - Q/Q change - SAAR 1.2% 0.7% to 2.6% 2.7% -1.0% -2.3%

Nonfarm productivity growth for the fourth quarter declined an annualized 1.8 percent, following a 3.7 percent jump in the third quarter. Expectations were for a 0.2 percent rise. Unit labor costs increased 2.7 percent after falling an annualized 2.3 percent in the third quarter. Analysts projected a 1.2 percent gain.

Output growth softened to 3.2 percent in the fourth quarter, following a 6.3 percent jump the prior quarter. Compensation growth posted at 0.9 percent annualized after 1.3 percent the quarter before.

Year-on-year, productivity was unchanged in the fourth quarter, down from 1.3 percent in the third quarter. Year-ago unit labor costs were up 1.9 percent, compared to up 0.9 percent in the third quarter.

The productivity and labor cost numbers continued to be volatile after the severe weather in the first quarter. Probably the most important number is year-ago compensation which eased to 1.9 percent from 2.2 percent in the third quarter. The Fed likely will see this as indicating soft labor market conditions.

Market Consensus Before Announcement
Nonfarm business productivity for the third quarter was revised up to an annualized 2.3 percent from the first estimate of 2.0 percent and following a 2.9 percent boost in the second quarter. Unit labor costs were revised down notably to minus 1.0 percent from a first estimate of up 0.3 percent after falling an annualized 3.7 percent in the second quarter. Output growth slowed to 4.9 percent in the third quarter, following a 5.5 percent jump the prior quarter. Compensation growth in the third quarter was up 1.3 percent annualized after a dip of 0.9 percent the previous period. Based on the initial estimate for fourth quarter GDP, there likely will be a slowing in productivity and firming in unit labor costs.

Productivity measures the growth of labor efficiency in producing the economy's goods and services. Unit labor costs reflect the labor costs of producing each unit of output. Both are followed as indicators of future inflationary trends.

Productivity growth is critical because it allows for higher wages and faster economic growth without inflationary consequences. In periods of robust economic growth, productivity ensures that inflation will remain well behaved despite tight labor markets. Productivity growth is also a key factor in helping to increase the overall wealth of an economy since real wage gains can be made when workers are more productive per hour.

Productivity and labor cost trends have varied over the decades. In the late 1990s, some economists asserted that dramatic productivity advances (based on new technologies) were then allowing the economy to sustain a much faster pace of growth than previously thought possible. Initially, some Fed officials expressed skepticism but later decided that productivity gains had helped boost economic growth and potential GDP growth during the 1990s. That is, the economy could grow faster than previously believed without igniting inflation.

Determining the source of productivity gains has become trickier over the last decade as new technology continues to be incorporated into production - not just in the U.S. but overseas also. Similarly, retraining U.S. workers has been sporadic. Not just low skill jobs are outsourced but now many highly skilled jobs such as programming and accounting are as well. Nonetheless, highly skilled professional jobs have been increasingly difficult to fill during times of high demand. Despite the cross currents in labor market trends, long-term productivity gains are important for maintaining growth in labor income and keeping inflation low.

But in the short-term, output and hours worked can shift sharply just due to cyclical swings in the economy. During the onset of recession, output typically falls before hours worked. This can result in a temporary drop in productivity and a spike in unit labor costs. So, while long-term productivity determines the "speed limit" for long-term growth, one should not be misled by short-term cyclical gyrations in productivity numbers as reflecting the true, underlying trend.