US: Productivity and Costs

Thu Nov 03 07:30:00 CDT 2016

Consensus Consensus Range Actual Previous Revised
Nonfarm productivity - Q/Q change - SAAR 2.2% 1.6% to 2.8% 3.1% -0.6% -0.2%
Unit labor costs - Q/Q change - SAAR 1.4% 0.7% to 1.5% 0.3% 4.3% 3.9%

Productivity has burst out of its slump, rising at a better-than-expected annualized pace of 3.1 percent in the third quarter. A revision to the second quarter also offers good news, 4 tenths improved but still negative at minus 0.2 percent in what was a third straight losing quarter in one of the worst runs in the long record of this report.

The third-quarter breakdown shows a surge in output, more than doubling to a 3.4 percent growth rate at the same time that growth in hours worked slowed sharply, to a 0.3 percent rate vs the second-quarter's 1.7 percent. Greater efficiency between output and hours worked holds down labor costs which rose only 0.3 percent which is much better than expectations.

Expectations for fourth-quarter growth are mostly positive, roughly at the same rate of the third quarter in what would set up another set of favorable productivity readings.

Market Consensus Before Announcement
First estimate for third-quarter non-farm productivity is expected to post the first gain in four quarters, at a plus 2.2 percent annualized rate. The expected gain is tied to improved third-quarter growth that in turn should limit unit labor costs which are expected to moderate to plus 1.4 percent from the second-quarter's sharp 4.3 percent increase.

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.