US: Productivity and Costs

February 2, 2017 07:30 CST

Consensus Consensus Range Actual Previous Revised
Nonfarm productivity - Q/Q change - SAAR 1.2% 0.5% to 2.6% 1.3% 3.1% 3.5%
Unit labor costs - Q/Q change - SAAR 1.8% 1.0% to 2.5% 1.7% 0.7% 0.2%

It took more hours to produce at a slower rate, that's an unfavorable mix for productivity which rose at only a 1.3 percent annualized rate in the fourth quarter vs an upward revised 3.5 percent in the third quarter. Output rose at a 2.2 percent pace in the quarter, down from the third quarter's strong 4.2 percent. Hours worked rose at a 0.9 percent rate vs the third quarter's very lean 0.6 percent.

Less output punch together with more hours is also a negative combination for unit labor costs which rose at a 1.7 percent rate vs only 0.2 percent in the third quarter. Year-on-year, labor costs are up 1.9 percent which is nearly double the rate for productivity where year-on-year growth is only 1.0 percent.

Low productivity is a stubborn weakness of the economy, the result in part of a shrinking pool of available workers but also reflecting lack of investment in new equipment.

Market Consensus Before Announcement
Non-farm productivity jumped out of its slump in the third quarter as output accelerated and hours worked slowed. Output, however, in the fourth quarter was not as strong as the third, pointing to slowing for productivity and increases for labor costs. Forecasters see nonfarm productivity rising 1.2 percent vs a 3.1 percent gain in the third quarter. Unit labor costs are expected to increase 1.8 percent vs 0.7 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.