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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 lesson will be online September 4 and will discuss the revised productivity growth rate for the second quarter.

KEY CONCEPTS

Economic Growth, Nominal Gross Domestic Product (GDP), Per Capita Gross Domestic Product (GDP), Production, Productivity, Real Gross Domestic Product (GDP)

Current Key Economic Indicators

as of November 10, 2014

Inflation

The Consumer Price Index for All Urban Consumers increased 0.1 percent in October on a seasonally adjusted basis. The core inflation rate increased the same amount. For the previous 12 months, the index increased 1.7%, the same rate as reported in the September report.

Employment and Unemployment

According to the October report of the Bureau of Labor Statistics, the unemployment rate fell from 5.9% to 5.8%, and the number of individuals unemployed also decreased. Total nonfarm employment rose by 214,000 in October. Employment gains were concentrated in retail trade, food services and health care.

Real GDP

The advance estimate for real GDP growth in the third quarter of 2014 was 3.5%, a decrease from the revised second quarter growth of 4.6%. Inventory investment reduced third quarter growth, while it added to second quarter growth. In addition, consumer spending increased at a lower rate in the third quarter, compared to the second. Finally, business investment increased in the third quarter, but at a lower rate than in the second quarter.

Federal Reserve

The FOMC believes that the labor market has shown considerable improvement and the risks of inflation rising above its 2% target are low. Therefore, the Federal Reserve announced plans to end its purchase of financial assets. In addition, the federal funds rate will remain at its current low level. However, the FOMC has signaled its willingness to increase the federal funds rate if inflation shows signs of rising above the 2% target.


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


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:
www.bls.gov/news.release/prod2.toc.htm

[Note to teacher: The material in this case study in italics is not included in the student version.

You may wish to use the following larger versions of the graphs and tables from this lesson for overhead projection or handouts in class:

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.)

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

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

figure2

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.)

How The Data Are Calculated

Productivity data represent the amount of goods and services (in real terms) produced per hour of labor. They do not identify the separate contributions of labor, capital, and technology. Changes in productivity include the effects of all (except hours of work) possible influences on output – technology, ability, skills, and effort of labor, capacity utilization, managerial skills, and the amount of capital.

Other periodic announcements report multifactor productivity indexes, which do measure the separate effects of hours of labor, education levels and experience of labor, amount of capital, and the effects of changes in technology.

Definitions of Productivity

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. Fluctuations in productivity measures in farming therefore may be only temporary.

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 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.)

    [Given an increase of 2.4 percent in real GDP during the year and an increase in productivity of 4.7 percent, employment (or at least hours worked) had to decrease. In actuality it did decrease by almost one percent. (The percentages do not match exactly as the productivity data, GDP, and overall employment changes include different industries.)]

  2. If productivity continues to grow rapidly during a slowly recovering growth in real GDP, what would you expect to happen to unemployment?

    [Employment will not rise rapidly and may even continue to fall. Thus, we should expect unemployment to potentially increase.]

  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.

    [Real output increased by 3 percent (5% – 2% = 3%). Productivity is output per hour worked. Thus the increase in productivity is 3 percent minus the change in the number of hours (one percent). Productivity increases by 2 percent.]

  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?

    [Labor inputs increase by 2 percent. Output per hour increases by the contribution of capital, education, and technology - 3 percent. Real GDP will thus increase by 5 percent. Given an inflation rate of 3 percent, nominal GDP will increase by 8 percent.]

  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?

    [Obviously such spending has benefits. Production should increase and we will be better off as a result of the increased spending. However, economic analysis would tell us that there are opportunity costs. If other productivity enhancing activities are given up as a result of the increase in government spending, it is less clear that such spending is wise.]