US: Productivity and Costs

Thu Feb 01 07:30:00 CST 2018

Consensus Consensus Range Actual Previous Revised
Nonfarm productivity - Q/Q change - SAAR 1.1% -0.5% to 2.6% -0.1% 3.0% 2.7%
Unit labor costs - Q/Q change - SAAR 0.9% -0.1% to 2.2% 2.0% -0.2% -0.1%

Fourth-quarter output did rise at a 3.2 percent annualized rate compared to the prior quarter, but it took 3.3 percent more hours to accomplish the increase. For productivity this is no improvement at all, falling 0.1 percent and near the bottom end of Econoday's forecast range. Compensation rose 1.8 percent which, relative to productivity, makes for a 2.0 percent rise in unit labor costs which is the high end of expectations.

Costs may be up but worker compensation, when adusted for inflation, actually fell at a 1.8 percent rate compared to the prior quarter. This is the latest bad news on wages and helps explain Monday's decline in the savings rate and may well explain what could be another jump in credit-card use in next week's consumer credit report.

The rise in costs in this report probably was absorbed in corporate profit margins and not passed through to final customers based at least on what have been stubborningly flat inflation data. High levels of employment pose a further risk that wage pressures may soon be triggered, pressures that would also, together with low productivity, have to be absorbed at the profit level.

Market Consensus Before Announcement
Fourth-quarter GDP came in at 2.6 percent which points to a respectable fourth-quarter productivity rate and no more than moderate pressure for labor costs. Forecasters see nonfarm productivity rising 1.1 percent in the fourth quarter vs 3.0 percent in the third quarter with unit labor costs seen up 0.9 percent vs a 0.2 percent third-quarter decline.

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.