US: Productivity and Costs

Thu May 04 07:30:00 CDT 2017

Consensus Consensus Range Actual Previous Revised
Nonfarm productivity - Q/Q change - SAAR 0.0% -0.4% to 0.5% -0.6% 1.3% 1.8%
Unit labor costs - Q/Q change - SAAR 3.0% 1.7% 1.3%

It took more hours to produce at a slower rate in the latest quarter in what is yet another unfavorable productivity report. Nonfarm productivity fell at an annualized 0.6 percent in the first quarter which is just below Econoday's low estimate. Weak productivity raises the cost of labor which came in well above expectations at an annualized 3.0 percent.

Output growth rose a modest 1.0 percent in the quarter while hours worked rose a less modest 1.6 percent. Compensation rose at a 2.4 percent rate though, after adjustment for inflation, actually contracted 0.8 percent. This follows no change for the price-adjusted reading in the fourth quarter and is another indication of wage weakness.

Looking at year-on-year data, productivity was up 2.4 percent from the first quarter last year which again is below labor costs which were up 2.8 percent. The breakdown shows a 1.3 percent rise in hours worked that is a mismatch with a 3.9 percent rise in compensation.

Weak productivity reflects lack of investment in new equipment along with lack of skills in the labor force. Weak productivity also holds down wages, and whether wages can recover from a weak March will be a major topic in tomorrow's employment report for April.

Market Consensus Before Announcement
Weak first-quarter GDP points to weak productivity, at a consensus no change and a resulting increase for unit labor costs where the consensus is 2.7 percent. Weak productivity, reflecting lack of investment in new equipment but also lack of skill in the labor force, has been the Achilles heel of the expansion.

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.