Monday, 11 of December of 2017

Economics. Explained.  

Category » Productivity

Nonfarm Productivity

December 6, 2017

Upon revision nonfarm productivity rose 2.9% in the third quarter after having climbed by 1.5% in the second quarter.   That is the  biggest single quarter advance in three years.  Something seems to be happening.  During the course of the past year productivity has risen 1.5%.  The 2.9% increase in the third quarter consists of a 4.1% increase in output and a 1.1% increase in hours worked.

Clearly, productivity growth slowed in the past 15 years. From 2000- 2007 (when the recession began) nonfarm productivity averaged 2.7%.  In the past three years it has slipped to 0.7%.

Some suggest that productivity is not properly capturing productivity gains in the service sector, particularly with respect to the internet.  For example, apps allow people to book airfares, hotels, and cars from their living room and get directions all at the same time.  But such gains do not appear to be captured anywhere in the productivity data.  The problem with that assertion is that manufacturing productivity  — which can be more accurately measured — has experienced a similar slowdown.  From 2000- 2007 (when the recession began) manufacturing productivity averaged 5.0%.  In the last three years it has fallen 0.3%.

Another part of the problem could be that retiring baby boomers could be leaving both their jobs and the labor force, and taking some of their knowledge with them which is adversely impacting the growth rate for productivity.

The basic problem however, in our view, is that businesses have been reluctant to invest despite a record stockpile of cash, near record low interest rates, and a booming stock market because they have been bothered by uncertainty about future tax rates, the inability to repatriate overseas earnings to the United States, the rising cost of health care which firms with more than 50 employees have to provide,  and an avalanche of onerous, confusing, and sometimes conflicting regulations.  But productivity growth is largely determined by the  pace of investment spending.  After several years in which nonresidential investment was essentially unchanged, it had a dramatic  surge to a 7.2% pace in the first quarter of this year, followed by an additional 6.7% increase in the second quarter, and 3.9% in the third.  This turnaround in corporate willingness to invest clearly reflects the prospect of imminent cuts in the corporate tax rate, the ability to repatriate earnings at a favorable tax rate, and general confidence about economic conditions both in the U.S. and abroad.

These major changes in policy should unleash a continuous wave of corporate investment spending, and because the pace of investment spending largely determines the rate of growth in productivity,productivity growth will climb from 1.0% or so today to 2.0%.  That, in turn, will boost the economic speed limit from 1.8% today to 2.8% within a couple of years.  If these changes actually happen they would represent the most significant economic events that  have occurred in years!

Stephen Slifer

NumberNomics

Charleston, SC


Unit Labor Costs

November 2, 2017

Unit labor costs might be a term that is not familiar to you.  Unit labor costs represent the increase in compensation adjusted for the gains in productivity.  You might think that if labor costs are rising that would put upward pressure on inflation.    It does not matter so much what wages are doing, but what wages adjusted for the change in productivity is doing.  Think of it this way.  If I pay you 3% more money, on the surface you might think that my costs as a businessman have just gone up by 3%.  That is not quite true.  What if you are 3% more productive?  Then I am getting 3% more output from you, so I really do not care.  I am very happy to pay you 3% more money.  In this case, unit labor costs, or labor costs adjusted for the gain in productivity, are 0%.  To take the example one step farther, if I pay you 3% higher wages but you are no more productive, then unit labor costs are rising by 3% and I am probably going to raise my prices to offset the higher cost of labor.  So, a gain of that magnitude in unit labor costs is quite likely to exert upward pressure on inflation.  So always watch what is happening to unit labor costs and not just wages.

Unit labor costs rose 0.5% in the third quarter after having risen 0.6% in the second quarter.  The third quarter increase consists of a 3.5% increase in compensation less a 3.0% increase in productivity.  During the past year unit labor costs have declined 0.1%.

Looking ahead into 2018 we expect compensation to increase by 3.5% given the tightness in the labor market.  But we also expect productivity growth to climb by 2.0%.  Hence unit labor costs should increase 1.5% versus a 0.1% decline currently.  If wage pressures (adjusted for the increase in productivity) are rising 1.5% that is entirely consistent with the Fed’s 2.0% inflation target.  Don’t worry about the sharp pickup in compensation to the 3.5% mark because much of that gain is being offset by faster growth in productivity.   Workers have earned their fatter paycheck.

Stephen Slifer

NumberNomics

Charleston, SC


Hourly Compensation

November 2, 2017

The Bureau of Labor Statistics indicated that compensation rose 3.5% in the third quarter after having climbed 1.8% in the second quarter and 4.8% in the first quarter.  This means that over the past year hourly compensation has climbed by 1.4%.

But, as noted in the section on unit labor costs, what really matters to an employer is not how much they pay someone, but how much they pay them adjusted for the change in productivity.  If I pay you 3% more money, but you are 3% more productive, I really do not care.  I am getting 3% more output from you.  That increase in labor costs adjusted for the change in productivity is known as “unit labor costs”.  If I pay you 3.0% more money but you are no more productive, then my unit labor costs have risen 3% and I may need to raise prices to compensate for the additional labor cost.  So watch compensation, but focus even more closely on unit labor costs.

Currently, unit labor costs have declined 0.1% in the past year.  Given that result, it is no wonder that the exceptionally tight labor market has not yet put any upward pressure on the inflation rate.  Increases in compensation are being exactly offset by gains in productivity.  Going forward, the tightness in the labor market should cause compensation to climb by 3.5% in 2017.  But imminent corporate tax cuts combined with an opportunity to repatriate earnings at a favorable tax rate, and steady progress in relieves the currently onerous regulatory burden, are boosting investment spending.  And since investment spending is the primary determinant of the growth rate of productivity, we expect productivity to grow by 2.0% in 2018.  As a result, unit labor costs in 2018 should rise by 1.5%.  That will put a moderate amount of upward pressure on the inflation rate, but it seems entirely consistent with the Fed’s 2.0% inflation target.

Growth in hourly compensation is a good thing, but some of that increase can be offset by inflation.  So what we are also  interested in is real hourly compensation.  In the third quarter real compensation rose 1.4% after having risen 2.1% in the second quarter and 1.7% in the first quarter.   The first quarter decline consisted of a 3.5% increase in compensation which was partially ofset by a 2.1% increase in inflation .  In the past year real compensation has declined 0.6% but that largely reflects a huge 7.5% drop in the fourth quarter of last year.  Looking ahead into 2018 we expect compensation to increase 3.5% as the tight labor market pushes wages higher, but that will be partially offset by a 2.3% increase in the inflation rate.  Thus, real compensation next year should increase by a solid 1.2%.

Stephen Slifer

NumberNomics

Charleston, SC