Productivity for the third quarter rose 3.0%, the largest one quarter increase since the third quarter of 2014 and over double the average quarterly growth rate since the start of 2009. This surge is significant, as weak productivity has contributed to U.S. economic growth, as measured by gross domestic product (GDP), to an average of just 2.2% since the end of the Great Recession. In fact, annual productivity growth has been under 1% since the fourth quarter of 2014. The only other period in recent history with productivity growth so slow was between 1981 and 1983. While productivity can fluctuate from quarter to quarter, supporting evidence from increased spending on capital goods and the slow continued unwinding of labor disruptions from the Great Recession lead us to believe that a return to a healthier rate of productivity growth may be here to stay
Part of the quarter’s growth may have been an offset for weakness in prior quarters. Even with the strong third quarter, year-over-year productivity growth remained a modest 1.5%, and the five-year average is only 0.8%. Manufacturing productivity, however, fell 5%, the worst level, excluding the Great Recession, since the U.S Bureau of Labor Statistics started tracking the data in 1987. Both the general growth in productivity and the decline in manufacturing may have been affected by hurricanes Irma and Harvey. The hurricanes seem to have caused more serious disruptions in less productive industries, such as food services, skewing the overall number somewhat higher. But within manufacturing, the hurricanes may have left equipment idle, causing manufacturing to look artificially weak.
Nevertheless, the strong number for the quarter is a move in the right direction. The recent rebound in shipments of non-defense capital goods excluding aircraft and rapid growth of private investment in equipment in the last two GDP reports (over 8% annualized real growth in the second and third quarter of 2017) are a positive sign that businesses are increasing investment in productivity, and the recent pickup may have staying power
If economic growth is going to increase, one either needs more hours of labor (from more people working or people working longer hours) or more output produced per hour worked. There is simply no other way to do it. The basic formula for productivity is the change in the amount of goods and services produced (the “product” of GDP) per hour of labor. More important than economic growth alone, productivity is the part of economic growth that flows through to improved standards of living. An economy will grow if more people work more hours, assuming productivity remains constant, but standards of living will remain the same. Growth would simply reflect a larger pool. But if productivity picks up, the value of an hour of work rises, often accompanied by increases in wages.
The recent third quarter provides a nice example. During the quarter, each person added 3% more value for each hour worked. At the same time, compensation for an hour of labor rose 3.5%. That 3.5% increase absent productivity increases would be difficult for companies to carry. But if you look at what it costs to produce an additional dollar of GDP, the costs rose only 0.5%. Looking back over the last four quarters, hourly compensation rose 1.4%, but productivity went up 1.5%, which means additional productivity more than offset increased compensation.
Over the long run, productivity growth and wage growth should stay in line with each other, keeping the labor share of income constant. The labor share of income declined sharply beginning in 2001 as productivity started to go down. A reversal in productivity may move the labor share of income back toward historical norms.
Increases in productivity are the key to raising GDP growth in a way that is sustainable, raises the standard of living, and helps provide an offset for rising wages. Recent data on productivity provide some early evidence that over a decade of slowing productivity may be starting to reverse. With capital equipment purchases rising, the decline in lingering labor disruptions from the Great Recession, and a workforce with an improving skill set to make better use of innovative technologies, the support structure for a reversal seems in place. Progress may be choppy and will be impacted by the ebb and flow of the global economy, but the odds are good that the third quarter was the beginning of a more enduring shift in the path of productivity growth.
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- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful
- Data provided by LPL Financial and the Bureau of Labor Statistics.
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- GDP is the monetary value of all finished goods and services produced with a country’s borders in a specific period. It includes all private and public consumption, government outlays, investments, and exports less imports that occur with a territory.