Current Thinking

A Few Notes on Labor Productivity

A blog by Frederic P. Slade, CFA, Assistant Vice President, Senior Director of Investments, Pentegra Retirement Services – May 12, 2015

Normally, when a worker has low productivity, it is not a good sign for that person’s pay or employment status. But what does it mean when overall productivity in the US economy is low or declining? Although it is not as widely publicized as inflation or the unemployment rate, the overall rate of labor productivity growth in the economy is closely watched by market economists and the Federal Reserve.

Labor productivity is defined as the total amount of output produced per hour of labor, and is reported quarterly for the US economy by the Bureau of Labor Statistics. When labor productivity is growing slowly or declining, this could actually be a signal that more workers are being hired. That is, the total number of hours worked is increasing, which, by definition, reduces the denominator of the productivity equation (output/hours worked). In the short run, lower productivity can indeed signal new hiring. However, this lower productivity can ultimately lead to higher prices and higher inflation as businesses attempt to maintain their profit margins in the face of higher labor costs. In turn, this higher inflation may lead to higher interest rates, which slow the employment benefit of the lower productivity rates.

The chart below shows quarterly growth rates in US productivity and total employment. Although the data has been volatile, declining productivity in a number of periods has been associated with higher employment growth and vice-versa, with a negative correlation of -0.25.

The next chart shows quarterly growth rates in US productivity and inflation. Here, it is more difficult to pinpoint whether lower productivity is associated with higher inflation, or vice versa. Part of a lack of correlation can be attributed to continued low rates of inflation in recent years.

Let’s look at earlier studies, when the inflation data used was more variable. In a 2005 paper by Janet Yellen1, the current Federal Reserve Chair, she suggested that after looking at productivity and inflation data over the 1995-2005 period, the predominant medium-term effect of a slowdown in productivity would likely be higher inflation. Another 2005 study by Robert Gordon and Ian Dew-Baker2 studied data over the periods 1965-1980 (productivity slowdown) and 1995-2005 (revival in productivity growth). Their analysis concluded that a decline in the productivity growth trend increased the inflation rate by at least one-for-one.

In conclusion, government statistics on overall US productivity growth can be volatile and should be treated with caution. However, lower productivity can be a signal of short run employment growth but could portend higher inflation to come. Conversely, a rally in productivity could have longer term beneficial effects by moderating potential upticks in prices.

1. Yellen, Janet. “Productivity and Inflation”, FRBSF Economic Letter 2005-04, February 2005.
2. Dew-Baker , Ian and Robert J. Gordon. “Where did the Productivity Growth Go? Inflation Dynamics and the Distribution of Income”, National Bureau of Economic Research Working Paper 11842, December 2005.

NOTE: Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Past performance is not a guarantee of future results.

About the Author

Frederic Slade

Frederic Slade is Assistant Vice President and Senior Director, Investments at Pentegra Retirement Services. He joined Pentegra in May 2007 as a Senior Analyst in the Investment Department and became Director-Investments in January 2013. He is responsible for managing over $1 billion in internal bond portfolios and providing asset/liability studies, analytics and product strategy for Pentegra’s Defined Benefit and Defined Contribution Plans. Mr. Slade is also a frequent contributor of economic and financial market blogs to Pentegra’s Talk to a Specialist website and the financial media. Prior to joining Pentegra, Mr. Slade was a Senior Quantitative Analyst at Citigroup Asset Management, providing asset allocation and quantitative stock screening for mutual fund products. Prior to Mr. Slade’s tenure at Citigroup, he was an Investment Manager at NYNEX Asset Management (now Verizon). At Verizon, Mr. Slade was responsible for asset allocation and planning for its $15 billion Defined Benefit pension fund. Mr. Slade holds a Ph.D. in Economics from the University of Pennsylvania and a CFA, and is a frequent presenter at industry seminars and conferences.




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