June 2024 Issue of the Employment in New York State Newsletter

 

Business economist Ed Yardeni calls productivity the “secret sauce” of economies. But what exactly is productivity? How is it measured, and why is it important? This article examines these issues and looks at the role productivity plays in today’s U.S. economy.

 

What is Labor Productivity?

When economists refer to productivity, they typically mean labor productivity, defined as output per labor hour. The U.S. Bureau of Labor Statistics (BLS) calculates it by dividing an index of real output (i.e., adjusted for inflation) by an index of hours worked by all workers, including employees, proprietors, and unpaid family workers. Per the BLS, the nonfarm business sector labor productivity measure is generally the most-reported productivity measure in the business press.

 

Official U.S. productivity numbers — which extend back to the 1940s — are compiled and published regularly by the BLS in their quarterly “Productivity and Costs” news releases. Quarterly changes in U.S. productivity levels are typically expressed as an annual rate of percentage change. In contrast, state-level productivity figures, which are calculated and released annually, only date back to 2007.

 

A recent article in Barron’s described U.S. productivity data as “volatile,” since it can bounce around significantly from quarter to quarter. For example, productivity fell at an annual rate of 3.3% in the fourth quarter of 2020, then turned positive (2.5%) in the first quarter of 2021 and then dipped by 0.1% in the following quarter. Due to that volatility, productivity is most commonly studied over long periods of time in order to better discern underlying trends from statistical “noise.”

 

Productivity Growth in Context

It is useful to put productivity growth rate figures in context. According to a BLS press release from June 2024, productivity during the current business cycle, which began in the fourth quarter of 2019, has grown at an annual rate of 1.5%. This rate reflects a 2.2% rate of growth in output and a 0.6% rate of growth in hours worked during the business cycle. This rate of annual growth matches the rate set during the last business cycle (fourth quarter of 2007 to fourth quarter of 2019). The long-term annual rate of productivity growth in the U.S. — since 1947 — is 2.1%.

 

The Importance of Productivity

In 1994, Nobel laureate Paul Krugman wrote: “Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.” BLS figures from the past two decades help to show the power of rising labor productivity.

From 2003 to 2023, the actual number of hours worked in the U.S. nonfarm business sector rose by 16.3%, or only about 0.8% each year. Yet, over this 20-year time frame, the U.S. saw a gain of 59.8% in real output, adjusted for inflation. What accounts for this outsized gain in real output?

 

One explanation is that labor productivity at the nation’s nonfarm businesses grew by 37.4% over this period. Some of the factors that affect the rate of labor productivity growth include:

• Physical capital (equipment and structures) per worker
• Human capital (knowledge and skills) per worker
• Natural resources per worker
• Entrepreneurship
• Technological knowledge

All of this suggests that it’s actual productivity, more than the amount of work done, that fuels production, consumption and (as a consequence) overall economic growth.

 

Productivity During Downturns

What happens to productivity growth during recessions? Until the 1960s, the conventional wisdom was that, when the overall economy was doing poorly, worker productivity would increase. The intuitive logic was that workers would work harder in downturns to lessen the chance of being laid off.

 

However, research by Yale economist Arthur Okun, chair of the Council of Economic Advisers in 1968-69, led him to dryly conclude, “[t]he record clearly shows that manhour productivity is depressed by low levels of utilization, and that periods of movement toward full employment yield considerably above-average productivity gains.” In other words, productivity actually tended to fall during recessions, and tended to rebound with the overall economy.

 

Writing about the Great Recession of 2007-09 and the “jobless recovery” that followed, economist Robert Gordon at Northwestern summarized how the conventional wisdom about productivity and downturns had changed. While Okun wrote that laying off employees was potentially expensive, Gordon wrote it was cheaper. Rising inequality had given employers greater power vis-à-vis labor, while the use of the Internet to match jobs and applicants directly reduced potential retraining costs, etc.

 

At least two papers — one published in 2012 by the Federal Reserve Bank of Minneapolis and the other published in 2014 by the BLS — suggested that the Great Recession should teach us that productivity has to be understood within the economic context of the time. Or, to paraphrase one of those papers, it might be less a puzzle to be solved than a factor to be considered and understood.

 

Productivity’s Role in Today’s Economy

Starting in March 2022, the Federal Reserve’s Open Market Committee hiked short-term interest rates a total of 11 times in order to contain widespread inflation in the U.S., which peaked at 9.1% in June 2022. This represented the nation’s highest rate of inflation since 1981. As a result, interest rates increased from 0% to 5.25-5.50%, making these hikes the most rapid cycle in U.S. history.

 

Ordinarily, economists expect such a rapid rise in interest rates to lead to an economic downturn, or to at least a slowing in economic growth. However, the productivity of U.S. workers at nonfarm businesses increased by 1.4% in 2023. This represented a dramatic turnaround from 2022, when annual productivity levels actually dropped by 1.9%. Some economists believe that the productivity surge in 2023 may help to explain why the overall U.S. economy was able to grow at a strong pace — real GDP increased by 2.5% in 2023 — while the nation’s annual inflation rate dropped from 8.0% in 2022 to 4.1% in 2023.

 

When considering productivity, it’s important to remember that workers can only be pushed so far. The reality of automation and the specter of generalized artificial intelligence, however, may point us toward a potential future where relatively few workers can maintain at least a semblance of strong outputs. This is a live topic these days, but also points in the direction of an economy most people likely would rather not have. But that’s a story for another day.

“In 2023, the Mohawk Valley enjoyed its third consecutive year of private sector employment growth.”