Productivity Update – August 7, 2003

The preliminary second quarter productivity growth rate 5.7%, was released on August 7. This is a faster rate of growth in productivity than during the first quarter revised productivity growth rate and faster than the rate (3.8%) over the last twelve months.

The next productivity case study will be online September 4 and will discuss the revised productivity growth rate for the second quarter.

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


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 in the nonfarm business sector--for the fourth quarter of 2002. The seasonally-adjusted annual rate of productivity growth was a negative .2 percent. For the entire year, the increase in productivity was 4.7 percent. Productivity change in the nonfarm business sector is the most commonly used gauge of productivity.

The original press release is available at:
[EEL-link id='1237' title='www.bls.gov/news.release/prod2.toc.htm' ]

Importance of Productivity Changes for Economic Growth

The decline in productivity is unlikely to be a signal of a significant change in the direct of productivity change. It is largely due rapidly slowing production and sales in the fourth quarter and the inability or unwillingness of businesses to cut employees. (In fact, hours worked actually increased slightly.)

Productivity increased over the entire 2002 year at a rate of 4.7%. That rapid rate of increase was partially expected as a normal reaction of an economy coming out of a recession. Businesses are normally slow to hire new workers as production and sales increase. Still the year’s increase was greater than following the previous two years, and in fact larger than any single year since 1950.

The rapid increase for the year continues to provide evidence of an end of the recession that started in March 2001. The latest Federal Reserve monetary policy announcements have referred to the strength of productivity growth as an extremely favorable sign of good economic conditions ahead. (See the recent FOMC cases.)


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Data Trends

In the fourth quarter, output in the nonfarm business sector increased (0.8 %) while hours of employees increased (1.0%). (See the latest Unemployment case for more on employment and unemployment.) If output alone increased, measured productivity will increase. The fact that 1.0% more hours (an even larger increase than the increase in output) were used to produce that output caused the decrease in measured productivity. Thus, the change in productivity was 0.8% - 1.0% = -0.2%.

The changes in productivity for all of 2002 were greater than any of the annual changes in recent years when productivity was actually increasing relatively rapidly. The increase in productivity in 2001 was 1.1 percent, while increases in 2000 and the previous four years were 2.9 percent, 2.4 percent, 2.6 percent, 2.0 percent, and 2.5 percent.

Hourly compensation rose at an annual rate of 4.6 percent during the quarter. 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 4.6% minus - 0.2% = 4.8%. This is the largest increase in unit labor costs since the third quarter of 2000. The increase in unit labor costs provides evidence that inflationary pressures exist, but few observers are concerned that they are significant or serious.

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 1050 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 percent of the recent increases 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 rest is not 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.)

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 changes in technology. Over time, real GDP in the U.S. has increased for all these reasons. We have a larger population with a larger percentage working. 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 into place.

The productivity measures capture the effects of the 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.

Questions

  1. Based on your knowledge of what happened to real GDP growth during 2002 and productivity changes during the year, what would you expect to have happened to employment during the year? Why? (See the GDP and Unemploymentcase studies.)
  2. If productivity continues to grow rapidly during a slowly recovering growth in real GDP, what would you expect to happen to unemployment?
  3. Assume that hours worked increase by 1 percent and that GDP increased by 5 percent. Also assume that the GDP implicit price deflator increased by 2 percent. Calculate the increase in productivity.
  4. Suppose the labor force increases by 1 percent and the hours per worker increase by 1 percent. Also assume that increases 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?
  5. An increase in government spending on research and development may enhance abilities to produce goods and in effect increase productivity. Is such spending wise?