US: Productivity and Costs

Wed Dec 02 07:30:00 CST 2015

Consensus Consensus Range Actual Previous
Nonfarm productivity - Q/Q change - SAAR 2.2% 2.0% to 2.5% 2.2% 1.6%
Unit labor costs - Q/Q change - SAAR 0.9% 0.7% to 2.0% 1.8% 1.4%

Wage pressures, especially relative to output, are appearing in the productivity and costs report. Unit labor costs, measured quarter to quarter, jumped to a much higher-than-expected annualized rate of 1.8 percent in the third quarter, up 4 tenths from the first estimate and twice expectations. The revised jump reflects a 4.0 percent rise in compensation, up from an initial 3.0 percent, and an upward revision to hours worked, now at minus 0.3 percent vs minus 0.5 percent.

What was supposed to contain labor costs was higher output, which indeed is revised 6 tenths higher to plus 1.8 percent. This helps lift productivity to a 2.2 percent rate, which is down from 3.5 percent in the second quarter but up from negative readings in the prior two quarters (minus 1.1 and minus 2.2 percent).

A look at year-on-year rates shows how soft productivity growth is, at plus 0.6 percent in the quarter vs a post-war average of plus 2.2 percent. Labor costs are up 3.0 percent year-on-year.

Though a rise in labor costs is not being signaled by other data, this report is certain to be considered closely by FOMC policy makers. Low productivity, and rising labor costs along with it, point to the effects of full employment and limited investment in new technologies.

Market Consensus Before Announcement
Held down by soft output, non-farm productivity came in at an initial plus 1.6 percent though some improvement, based on a 6 tenths upward revision to third-quarter GDP to plus 2.1 percent, is expected for the second estimate, at plus 2.2 percent. Better output in turn is expected to lower third-quarter unit labor costs which are expected to be revised to plus 0.9 percent from plus 1.4 percent in the first estimate.

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.