Thursday, February 4, 2010

Productivity Surges

Nonfarm productivity surged 6.2% in the fourth quarter of last year, following a downward revised- but still impressive- gain of 7.2% in the prior quarter. (In fact, the Q3 gain was the biggest quarterly increase in the series since Q3 of 2003). In the second quarter of 2009, the series had also surged 6.9%. As a result, on a year-on-year basis, productivity is now up a stellar 5.1%.

However, the spectacular gains in productivity in the last few quarters are hardly unexpected.

From the analytical standpoint, productivity consists of a cyclical and structural component. It is typical for the series to show outsized increases in the early phase of an economic expansion, as businesses tend to use their existing, underutilized, labor force more intensively for a while before they are convinced that an economic recovery is taking hold and start hiring more workers. Once that process runs its inevitable course and hiring picks up, productivity gains are bound to moderate precipitously again.

So, it is hardly surprising that, with economic activity bottoming out around mid-2009, productivity gains have spiked. The obvious message here is that they should not be celebrated as representing any improvement in long-term productivity trends in the U.S. economy but simply as a reflection of the economic juncture. It would take several years of a perceptible uptrend in the series to reach the conclusion that something more fundamental is happening. In fact, as the chart below shows, the current productivity surge is nothing exceptional by the standards of the behavior of the series in the early phase of the two previous economic recoveries during 1992-93 and 2002-03.

Nonfarm Business Productivity

Source: Bureau of Labor Statistics

Unit labor costs, which are essentially the mirror-image of productivity have been trending lower in recent quarters.; they fell 4.4% in Q4, following a 1.5% drop in Q3, and are now down 2.8% from a year ago. Once again, it confirms the weak state of labor markets and absence of wage pressures- not exactly surprising against the backdrop of labor slack and a 10% unemployment rate.

The spike in productivity in recent quarters helps explain how GDP growth has been taking off (averaging nearly 4% in the second half of 2009), while the erosion of jobs continues (albeit at a much slower pace). This is indeed plausible for some time but cannot remain the case moving forward, as ultimately a pick up in employment would be needed to support income growth and consumption. So, the mirage of economic growth co-existing with the absence of job creation is essentially on short leash.

Anthony Karydakis