US: Productivity and Costs

Thu Nov 05 07:30:00 CST 2015

Consensus Consensus Range Actual Previous Revised
Nonfarm productivity - Q/Q change - SAAR 0.1% -1.0% to 2.8% 1.6% 3.3% 3.5%
Unit labor costs - Q/Q change - SAAR 2.2% 0.5% to 3.5% 1.4% -1.4% -1.8%

Lower output pulled down productivity growth and pushed up unit labor costs in the third quarter. Productivity rose 1.6 percent in the quarter which is in the middle of the Econoday consensus range but well above the plus 0.1 percent median. Unit labor costs came in at a lower-than-expected plus 1.4 percent.

Output slowed to plus 1.2 percent in the third quarter vs 5.1 percent in the second quarter. Limiting the rise in labor costs was a 0.5 percent decline in hours worked, which is the first decline in five years. The decline here, however, was offset by a 3.0 percent rise in compensation.

A look at year-on-year rates shows how soft productivity growth is, at plus 0.4 percent in the quarter vs plus 0.8 percent in the second quarter and vs a post-war average of plus 2.2 percent. Labor costs are up a year-on-year 2.0 percent vs the second quarter's plus 1.6 percent. Low productivity is consistent with full employment and an aging economic cycle.

Market Consensus Before Announcement
Non-farm productivity is expected to show little change in the third quarter, at a consensus plus 0.1 percent. In contrast, unit labor costs are expected to show pressure, up 2.2 percent and reflecting the third-quarter's moderate growth rate. Soft growth, higher labor costs together with tight labor supply is an inflationary combination for policy makers.

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.