Breaking Down Productivity

Bloomberg details:

The productivity of U.S. workers slowed in the first quarter and labor costs rose as companies boosted employment to meet rising demand.

The measure of employee output per hour increased at a 1.8 percent annual rate after a 2.9 percent gain in the prior three months, revised figures from the Labor Department showed today in Washington. Employee expenses climbed at a 0.7 percent rate after dropping 2.8 percent the prior quarter.

“Productivity growth has slowed in the past year but from very strong rates and it remains fairly decent,” Sal Guatieri, a senior economist at BMO Capital Markets in Toronto, said before the report. “Labor costs have moved higher because of the slowing in productivity growth, but they were generally falling for some time and remain very weak, essentially implying no threat to the inflation outlook.”

Let us dive into the numbers...

The first chart below shows total productivity broken out between its two components... hours worked and output per hour (you can only increase productivity by increasing one or the other).

Rolling One Year Change



A few points to notice... the snap back post recession was relatively small as compared to past downturns (especially considering how far things fell - a rebound to trend would have appeared especially large in itself) and the pace of productivity growth is slowing.

Rolling Five Year Change

The longer term trend above shows why we are feeling so much pain; we are at a multi-generational low in total productivity, almost entirely driven by the unprecendented decrease in hours worked.

The next chart outlines (in my opinion) the bigger story. It is the change in the productivity to hours worked ratio over rolling ten year periods. As an example of how to interpret the chart, the most recent period shows a change of around 40%. What this means is that productivity has grown by about 40% relative to hours worked over the past 10 years (they've grown 30%, while hours are down about 8%). This is by far a multi-generation high.



This helps explain a lot of the current situation. While productivity in itself is not a bad thing at all (in fact, I would argue it is one of the most important things for sustained economic growth), when productivity is increasing solely to offset hours worked, a lot of structural imbalances result UNLESS there is policy (education, reallocation from those that benefit to those that suffer, etc…) that helps transition the broader economy to a new “balance”. If this does not happen, workers replaced with new productive resources find themselves not only suffering personally, but dragging the economy down as they are no longer adding to the hours worked component of productivity (as I mentioned, it is one of only two inputs).

The other important question is whether the productivity is truly an increase in productivity or just a shift in the hours worked component from the U.S. to those abroad. As I’ve outlined here, over the last 10 years (i.e. when the output / hours worked ratio spiked in the chart above) there was a huge labor supply shock coming from emerging Asia. My concern is that we are not really becoming all that more productive with new technologies, process, etc..., but simply outsourcing a lot of the hours worked overseas. This would explain a ton, including the strength of emerging Asia relative to the U.S., the disparity between “haves” and “have nots” by educational attainment (i.e. the economic slump has been felt to a much greater extent by those with less education whose jobs have been exported), and the soaring profits by corporations even in the face of lower growth (cutting costs vs. increasing revenues).

Source: BLS