Counterproductive Handwringing Over Productivity

In September, the US Bureau of Labor Statistics revised its earlier estimate of Q2 nonfarm business sector labor productivity. Following the revision, the report showed worker productivity declined at a -0.7% annual rate in the quarter. So what drove the decline? Not a dip in output, which rose at a +1.3% annual rate. Rather, it was that a +2.0% gain in average hours worked outstripped the rising output. Which, while the numbers vary somewhat, is very similar to Q1 2011.

Without doubt, productivity is a critical component of the US economy and one of the fundamental strengths behind America’s highly competitive private sector. So it isn’t terribly surprising some mediasources have recently homed in on the headline dip and drawn some relatively vast conclusions. Some speculate this is bad for private-sector hiring prospects. Others postulate it means government estimates of where GDP will be five years from now are wrong. Others speculate it means higher federal budget deficits.

A bit of perspective: Government revisions to old data are normal, and these archeological digs aren’t typically very impactful for markets. But also, that productivity dipped in Q1 and Q2 isn’t abnormal in an expansion. Typically, productivity sharply rises as recession abates, followed by much more uneven growth. Over time, the result is a more gradual increase in productivity during expansions overall.

And that makes sense—as businesses cut costs to stay afloat during recessions, they pare back hours for workers, maybe even lay folks off. Essentially, they try to wring every bit of output they can from each worker and every hour worked. But as the economy—and businesses’ sales—recover, increasing volume eventually stretches these workers to the limit. Even with technological advances, there’s still a point at which a bare-bones workforce can’t meet demand in a timely fashion, which can cost a company sales—something management would obviously like to avoid. All this is essentially a cog in the economic machine ultimately causing growth to work through slack in the labor force (unemployment).

And that seems to be what’s likely at work here. After all, US corporate revenues have risen for seven consecutive quarters (Q3 will likely mark eight)—at a 12% clip in Q2.[i] And it isn’t like actual business output fell—it grew! So with that backdrop—a growing economy, increasing sales and rising private-sector output—two quarters of slightly shrinking productivity doesn’t strike us as a bad thing at all. In fact, it could represent the fact many businesses have added to payrolls—and may have to further increase them soon. Now, as businesses move forward, there’s little reason productivity couldn’t reaccelerate in volatile fashion. Firms could, for example, spend cash on technology upgrades ultimately buoying output per hour. So digging below the headline number shows a couple quarters of slightly dipping productivity isn’t truly some major negative—or necessarily negative at all.

But there’s also speculation volatile productivity statistics mean the government’s long-term growth projections are wrong. Ask yourself this: When have long-range government projections been right? (Crickets.) After all, these are the very folks who brought you 2000-era forecasts of budget surpluses for a decade. Just a tad off. Ultimately, this all seems to us fairly typical productivity volatility—and volatility off what had been very high productivity levels to boot.

[i] Source: Standard and Poor’s Compustat, Standard and Poor’s.