Last week, the Bureau of Labor Statistics released the second quarter estimate of labor force productivity in the US. The report indicated that for the last three quarters, productivity has actually fallen in this country. While this is troubling, three quarters hardly represents a trend, but we thought it would be worthwhile to discuss the situation from a couple perspectives.
First, long-term growth (by this we mean over decades) is simply tied to two key metrics. These are the growth in labor force and the growth in productivity of the labor force. In the US, labor force growth over the past couple decades has been about 1%. Since 1986, productivity has grown at a 1.9% rate. Over the last three decades our economy has grown at a 3% rate on average. Japan, with a shrinking labor force, and similar productivity growth has been stagnant. Should we worry? Not yet, three quarters does not constitute a trend.
Second, corporate profits are directly tied to productivity growth. The rate of change in profits is roughly equal to the ability of a corporation to increase the prices of goods sold, offset by the increase in the cost of labor and the cost of inputs (the latter is known as Producer Prices or PPI). These two costs are offset by increases in productivity. So a corporation can offset higher costs with higher productivity. Should we worry? Not yet, while productivity is falling so is PPI. Input prices of all types are stagnant or lower. This can’t last forever. Eventually labor and input costs may rise. Typically businesses respond by finding labor/material saving innovations (i.e. productivity). So, part of the current productivity problem is that falling PPI keeps the pressure off corporations to innovate.
Finally, short-term growth is also impacted by productivity. While productivity is falling, our economy continues to grow at a 1-2% rate. Not great but not recession, and we may be accelerating a bit. Should we worry? Not yet, two things are happening currently to offset falling productivity. First, the velocity of money is increasing modestly. This simply means more turnover in the money supply (i.e. more lending, more spending, etc.) Second, and this is directly related to the first metric, consumer spending is strong, offsetting falling productivity. The economy does need to turn the productivity equation around but there is no urgency yet.
Disclosures: This piece discusses general market activity, industry or sector trends, or other broad-based economic, market , or political conditions and should not be construed as research or investment advice. The opinions expressed are those of the author and do not necessarily represent the opinions of Enterprise Bank & Trust. Past performance is no guarantee of future performance. No diversification strategy can guarantee against loss.