Nonfarm productivity growth was revised down to an annualized rate of 1.7 percent in the fourth quarter from 3.0 percent, below Econoday's consensus of 2.5 percent. Unit labor costs were up 3.2 percent, an upward revision from 1.1 percent, topping expectations that had ranged from 1.0 percent to 1.9 percent.

The lower productivity estimate resulted from a downward revision to output growth to 3.1 percent from 3.5 percent, combined with an upward revision to hours worked now up 1.4 percent, compared to 0.5 percent initially reported. Hourly compensation was also revised up to 4.9 percent from 4.1 percent, although it was revised down after adjusting for inflation.

The pattern was similar in manufacturing, with productivity down 2.7 percent, more than the 1.5 percent drop initially reported, while unit labor costs were revised up to 7.7 percent from 4.8 percent.

In 2022, annual average productivity declined 1.7 percent from 2021, the largest drop since 1974. Meanwhile, unit labor costs rose 6.5 percent, the largest annual increase since 1982.

The second-estimate for fourth-quarter nonfarm productivity is expected to show a 2.5 percent rise versus a 3.0 percent annualized gain in the first estimate. Unit labor costs, which slowed from 2.4 percent in the third quarter to 1.1 percent in the first estimate for the fourth quarter, are expected to rise at a 1.4 percent rate in the second estimate.

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.