US: Productivity and Costs

Wed Jun 06 07:30:00 CDT 2018

Consensus Consensus Range Actual Previous
Nonfarm productivity - Q/Q change - SAAR 0.7% 0.3% to 0.8% 0.4% 0.7%
Unit labor costs - Q/Q change - SAAR 2.8% 2.7% to 3.0% 2.9% 2.7%

A small downward revision to output and a small upward revision to hours worked pulled down the second estimate of first-quarter nonfarm productivity to an even more paltry 0.4 percent quarterly gain from 0.7 percent in the first estimate. This in turn lifts unit labor costs to 2.9 percent from the first estimate's 2.7 percent.

Looking at year-on-year change, productivity rose 1.3 percent in the first quarter, which is right in line with trend, while labor costs also rose 1.3 percent which is an improvement from the fourth quarter's 1.8 percent rise.

When adjusted for inflation, real compensation remains in the negative column at a quarterly annualized rate of minus 0.2 percent. Readings in this report are all vital signs for the economy and the results point to subdued labor activity consistent with a mature expansion and high levels of employment.

Market Consensus Before Announcement
There was little change in the second estimate of first-quarter GDP and little change is the expectation for the second estimate of first-quarter productivity, at 0.7 percent growth to match the first estimate with unit labor costs at 2.8 percent vs the first estimate's 2.7 percent. Output slowed in the first quarter but so did hours worked while compensation rose.

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.