Announcement

The Bureau of Labor Statistics of the U.S. Department of Labor today reported preliminary productivity data--as measured by output per hour of all persons--for the third quarter of 2002. The seasonally-adjusted annual rate of productivity growth in the third quarter was 4.0 percent. This figure measures changes in what is described by the Bureau of Labor Statistics as the nonfarm business sector and is the most commonly used measure of changes in productivity.

The original press release is available at: www.bls.gov/news.release/prod2.nr0.htm

Definitions of Productivity

Productivity is the amount of output per hour worked. For example, real output in nonfarm business increased by 4.1 percent (at an annual rate). The number of hours increased by 0.1 percent. The increase in the number of hours was responsible for a very small increase in output. An increase in productivity (output per hour) was the difference (4.0 percent).

It is a challenge to understand all of the different productivity measures. Changes in productivity are calculated for the business sector, the nonfarm business sector, manufacturing (including calculations for durable goods and nondurable goods manufacturing), and even nonfinancial corporations.

The broadest measure is productivity in the business sector, which comprises 77 percent of GDP. The business sector excludes government and nonprofit organizations, employees in private households, and the rental value of owner-occupied housing. The nonfarm business sector excludes all of those activities plus farming and accounts for about 76 percent of GDP. Productivity in the nonfarm business sector is the most commonly used measure in studies of productivity. The reason agriculture is removed is because output and therefore productivity are significantly influenced by weather changes.

Nonfinancial corporate output measures productivity for the nonfarm business sector excluding such activities as banks, securities brokers, insurance carriers, and unincorporated businesses. It accounts for 53 percent of the value of GDP. Manufacturing includes about 17 percent of business employment. The manufacturing of durable goods includes machinery, computer equipment, electronics, appliances, automobiles and trucks, lumber, furniture, and stone, glass, and cement products (11 percent of employment). Manufacturing of nondurable goods (6 percent of employment) includes food, apparel, paper products, publishing, chemicals, and petroleum products. The manufacturing data are actually calculated from different sources than the overall statistics and can differ slightly from the other data.

Importance Of Productivity Changes For Economic Growth

Our capacity to produce goods and services is determined by how much labor we have, how many hours workers work, the workers' skills and intensity of work, the amount of capital workers have with which to work, and to technology. Over time, real GDP in the U.S. has increased as all of these have changed. We have a larger population with a larger percentage working, and in the last ten years, the average worker has been working longer hours. The workers have significantly larger amounts of capital and new ways of producing and organizing production have been put in place.

The productivity measures capture the effects of that increased capital, the increased experience and education of workers, and the new technology. If productivity increases faster than population growth, real GDP per person can increase and we can all enjoy higher standards of living.

Increases in productivity mean that workers can earn higher salaries without prices being forced upward. Increases in productivity allow profits to increase without significant increases in sales.

Recent Trends

Productivity growth often slows or disappears in recessions and indeed the growth in productivity throughout 2001 (1.1%) was significantly slower than in 2000 (2.9%). The rather rapid increase in the fourth quarter of 2001 (7.3%) and the even faster rise in the first quarter of 2002 (8.6%) appeared to many as evidence that the economy was likely coming out of the recession.

The second quarter 2002 number (1.7%) was sharply lower than the previous two quarters, but still represented positive growth. The relatively strong numbers for the third quarter (4.0%) continue the evidence pointing to an end of the recession. In fact, the total increase of 5.3% over the last twelve months is higher than we have experienced in a long time. The latest Federal Reserve release (See the recent FOMC case.) refers to the strength of productivity growth as a reason for continued confidence in the long-run trends in the economy.

Figure 1: Changes in Nonfarm Business Productivity (Percent Change in Output per Hour) Quarterly Changes 1998-2002

Data Trends

The latest productivity data indicate that businesses are adapting to the slowdown in growth in total output that occurred throughout 2001 by adjusting employment and the hours worked. However, now it appears that employment may be beginning to rise once again (or at least not falling). Employment decreased during 2001 and businesses reduced the hours worked by each employee as well. However in the latest quarter businesses have increased the hours worked by their employees, but very slightly (+0.1%). (See the latest Unemployment case for a description of recent changes in employment.)

In the third quarter, output in the nonfarm business sector increased (4.1%) while hours of employees increased (.1%). Increases in output alone will increase measured productivity by that rate of increase. The fact that .1% more hours were used to produce that output slightly decreases the measured productivity. Thus, the change in productivity was 4.1% - .1% = 4.0%.

The changes in productivity during 2001 were less than the changes in the previous three years. The increase in productivity for all of 2001 (1.1 percent) is less than increases in 2000 (2.9 percent), 1999 (2.4 percent) and 1998 (2.6 percent). This is the lowest rate of productivity growth since 1995, and less than the average rate of change in productivity over the previous twenty years.

The longer run trend in productivity over the past decade has allowed real GDP per capita to increase. It also means that wages for workers can increase and can do so without excessive upward pressures on prices. Unit labor costs are the costs of labor per unit of output. Thus the increase in unit labor costs is the percentage increase in hourly compensation minus the percentage increase in productivity. Or 4.8% minus 4.0% = .8%. This very small increase in unit labor costs provides evidence that inflationary pressures do not exist.

In the short run, increases in productivity may mean that as the economy recovers from the recession, it will do so without large increases in employment.

Historical Data Trends

Figure 2: Changes in Nonfarm Business Productivity (Percent Change in Output Per Hour) Annual Changes 1970-2001

From 1950 to 1973, productivity grew at an average annual rate of 2.8 percent. But from 1973 to 1995, growth in productivity slowed to an increase at an annual rate of 1.4 percent. From 1996 to 2000, productivity increased at an annual rate of 2.5 percent, almost equal to the 1950 to 1973 rate.

The slowdown, beginning in the 1970s, and the increases in the late 1990s are not fully understood. The analysis of the Council of Economic Advisers is that about .47 of one percent of the recent increases (+1.1 percent annually) can be explained by the effects of more computers and software being used in many businesses. Dramatic changes in the production of computers themselves helps explain about another .23 percent. The quality of labor (increased education and more experienced workers) explains about .05 percent.

The source of the rest (.35 of one percent) is not well understood. It may be due to cyclical pressures (that is, fewer workers were being added to employment rolls, but those who were working were producing more) and perhaps to the effects of lower business costs as a result of business use of the internet.

For the future, education and experience will not likely continue to make significant advances. The computer contribution to increases in productivity will probably drop. A consensus forecast is for a declining growth rate in productivity and therefore in real GDP growth rates.

  1950 -73 1973 - 95 1995 - 00 Future
Growth in hours worked 1.6% 1.7% 1.7% 1.2%
Productivity 2.8% 1.4% 2.5% 2.0%
Real GDP 4.2% 3.0% 4.0% 3.0%

(The numbers do not add in all cases due to rounding and the inclusion of slightly different measures in the productivity and hours calculations. However, increases in the growth in hours worked and increases in productivity will cause similar increases in the growth rates of real GDP.)

Questions

  1. Assume that hours worked increase by 2 percent and that GDP increased by 4.5 percent. Also assume that the GDP implicit price deflator increased by 1.5 percent. Calculate the change in productivity.
  2. Suppose the labor force increases by 1 percent and the hours per worker increase by 2 percent. Also assume that expansion in the amount of capital increases output per worker by 2 percent. Prices increase by 3 percent. Increases in education and technology increases output per hour by 1 percent. What are the rates of increase in real GDP and GDP?
  3. What are the primary historical contributors to increases in productivity?