US: Productivity and Costs

Wed Dec 06 07:30:00 CST 2017

Consensus Consensus Range Actual Previous
Nonfarm productivity - Q/Q change - SAAR 3.2% 2.8% to 3.3% 3.0% 3.0%
Unit labor costs - Q/Q change - SAAR 0.3% -0.3% to 0.7% -0.2% 0.5%

This year's pickup in the economy combined with thin wage growth is helping to improve productivity and unit labor costs, the former unrevised at a 3.0 percent annualized rate in the third quarter with the latter down 0.2 percent from an initial plus 0.5 percent. Output, at annualized growth of 4.1 percent, and hours worked, rising at a 1.1 percent pace, were both revised 3 tenths upward to keep productivity unchanged, while compensation was revised 8 tenths lower 2.7 percent to pull down costs.

Underscoring the weakness in wages is a downward revision to second-quarter labor costs which are revised from a 0.3 percent gain to a 1.2 percent decline. Second-quarter productivity growth holds at 1.5 percent. Real compensation growth in the third quarter, that is adjusted for inflation, is now at plus 0.7 percent, down from an initial rise of 1.5 percent.

The third quarter was a strong one for output that outpaced recent quarters, evident in year-on-year rates that show less strength for productivity, at only 1.5 percent. Year-on-year unit costs were down 0.7 percent in the quarter.

Gains in output that outstrip gains in hours worked is a healthy combination. The question is whether and when full employment will begin to drive up wages.

Market Consensus Before Announcement
Third-quarter GDP was revised 3 tenths higher to 3.3 percent which points to added strength for third-quarter productivity and to additional easing for labor costs. Forecasters see nonfarm productivity rising 3.2 percent in the second estimate vs 3.0 percent in the first estimate with unit labor costs up 0.3 percent vs an initial 0.5 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.