US: Productivity and Costs

Wed Sep 02 07:30:00 CDT 2015

Consensus Consensus Range Actual Previous
Nonfarm productivity - Q/Q change - SAAR 2.8% 1.6% to 3.3% 3.3% 1.3%
Unit labor costs - Q/Q change - SAAR -1.2% -1.4% to 0.4% -1.4% 0.5%

The upward revision to second-quarter GDP gave a strong lift to nonfarm productivity, up 3.3 percent at an annualized rate which is at the very top of the Econoday consensus and well up from plus 1.3 percent in the initial reading. This is the best performance since the fourth quarter of 2013.

The gain in productivity in turn drove unit labor costs 1.4 percent lower which is well down from the prior estimate of plus 0.5 percent and at the very low end of consensus and the sharpest drop since the second quarter of 2014. Output rose a sharp 4.7 percent in the quarter while hours worked rose only 1.4 percent with compensation up only 1.8 percent.

But year-on-year data tell a different story with productivity up 0.7 percent in the second quarter and labor costs up 1.7 percent. These readings reflect prior weakness in productivity tied to weak output in the first and fourth quarters.

And the productivity outlook for the ongoing third quarter is also soft with early GDP estimates at roughly plus 2 to 2.5 percent. For reference, second-quarter GDP came in at 3.7 percent, revised from a prior reading of 2.3 percent.

Market Consensus Before Announcement
The second estimate for productivity & costs is expected to show a rise in productivity growth to 2.8 percent from 1.3 percent reflecting the upward revision to second-quarter GDP. Higher productivity points to lower unit labor costs which are expected to fall 1.2 percent.

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.