US: Productivity and Costs

Wed May 06 07:30:00 CDT 2015

Consensus Consensus Range Actual Previous Revised
Nonfarm productivity - Q/Q change - SAAR -1.9% -2.5% to -1.2% -1.9% -2.2% -2.1%
Unit labor costs - Q/Q change - SAAR 4.6% 3.8% to 5.6% 5.0% 4.1% 4.2%

The grinding halt that the economy came to the first quarter pulled nonfarm productivity down by 1.9 percent and inflated unit labor costs by 5.0 percent. Output as measured in this report fell 0.2 percent in the quarter at the same time that hours worked rose 1.7 percent. Adding to labor costs was a sharp 3.1 percent rise in compensation, up from 1.9 percent in the prior and the strongest since first-quarter 2014.

Looking year-on-year, productivity moves to the plus side, though just barely, at 0.6 percent with labor costs much more tame, at plus 1.1 percent. Should the second-quarter see the big bounce as many suspect, productivity, compared to the first quarter, should improve and labor costs cool.

Market Consensus Before Announcement
Weakness in first-quarter GDP, up only 0.2 percent, points to a decline in productivity and a rise for unit labor costs. Productivity is expected to fall 1.9 percent in the quarter which would be a second straight decline. And costs are expected to post their second straight jump, up 4.6 percent in a gain that would be in line with pressure in last week's employment cost index.

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.