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Current Business Developments
Robert C. Fry, Jr., Ph.D.
DuPont Economist’s Office
November 19, 2009
PRODUCING MORE OUTPUT WITH FEWER WORKERS
Productivity & Labor Costs: US Non-farm Businesses
Productivity, as measured by output
per hour of all workers in the U.S. non-farm
15
15
Shaded areas denote recessions
business sector, rose at a 9.5% annual rate in
the third quarter, the fastest advance since
Output per Hour
Unit Labor Costs
10 the third quarter of 2003 and the second
10
fastest since 1983. Output rose at a 4%
annual rate, while hours worked declined at a
5% rate. Compensation per hour rose at a
5
5
3.8% annual rate, but because this was so
much less than the increase in output per
hour, unit labor costs (labor costs per unit of
0
0
output) fell at a 5.2% rate. This was the third
consecutive quarter of big declines in unit
labor costs, leaving them 3.6% below year-5
-5
60 65 70 75 80 85 90 95 00 05 10
earlier levels. This marks the biggest yearover-year decline in unit labor costs since the data series began in 1947.
Percent Change from Year Ago
It is not unusual for productivity to grow rapidly in the early stages of an economic recovery.
Employers are generally reluctant to hire until they are convinced the recovery is for real and instead try
to squeeze more output out of their existing workforces. What is unusual is that productivity did not
decline during the severe 2007-2009 recession. In each of the six U.S. recessions from 1957 through
1982, productivity growth turned negative on a year-over-year basis, as employers cut hours worked by
less than they cut output. This pattern started to reverse itself in the 1990-91 recession, when
productivity growth stayed positive on a year-over-year basis. Productivity growth then surged during the
2001 recession. However, these were unusually mild recessions, making it hard to conclude that the
cyclical behavior of productivity had permanently changed. The continued growth of productivity during
the 2007-2009 recession makes a much stronger case. Perhaps because of pressure from Wall Street
to cut costs and protect corporate earnings, U.S. businesses now cut hours during a recession by more
than they reduce output, and they continue to reduce hours even after output has turned up in the
ensuing recovery. As a result, unemployment rises more than one would expect for a given decline in
GDP, and it continues to rise long after the business-cycle trough. (Until the jobless recovery from the
1990-91 recession, unemployment usually peaked within two months of the business-cycle trough.)
The surge in productivity growth and associated decline in unit labor costs is good for corporate
profits and accounts for the better-than-expected earnings reports in the third quarter. (The
government’s measure of “economic profits” for the third quarter will be reported with the revision of third
quarter GDP at the end of this month. A big increase is expected after smaller increases in the first and
second quarters.) Rising profits normally translate into higher capital expenditures and more hiring.
Consequently, profits are sometimes included in indexes of leading economic indicators. Declines in real
unit labor costs (unit labor costs adjusted for inflation) have been used as a leading indicator of
employment growth. Since productivity growth contributes both to rising profits and falling unit labor
costs, it is also included in some leading indexes. Rising productivity and profits and declining unit labor
costs are all sending positive signals for economic growth over coming months. Declining unit labor
costs also make a significant acceleration in inflation very unlikely in the short run.
Perhaps the biggest risk to the current recovery is that higher profits and lower labor costs will not
translate into hiring the way they did in the past. In the near term, the U.S. economy can grow on the
basis of government spending, and end to the inventory drawdown, and small rebounds in housing starts
and motor vehicle sales; no contribution from non-auto consumer spending is needed. However, by the
middle of next year, government spending starts to decline and fiscal stimulus turns to fiscal drag. With
the U.S. dollar weakening and emerging markets growing rapidly, exports could pick up much of the
slack, but if consumer spending does not accelerate to a healthy pace (albeit slower than in past
recoveries) by that time, the recovery will be at risk. Consumer spending is unlikely to accelerate
significantly unless employment starts growing again and the unemployment rate begins to decline.
The U.S. economic recovery continues for now, but the lack of employment growth may already
be holding back its pace. Retail sales excluding autos and gasoline rose for a third consecutive month in
October, but the increases have been small. U.S. industrial production rose just 0.1% in October, and
production in manufacturing actually fell 0.1% after three months of strong increases. Housing starts
plunged in October, presumably reflecting the since-delayed expiration of the first-time homeowners’ tax
credit. Recovery has begun in much of the Euro-zone, but it is slow there as well. Real GDP for the
Euro-zone was up 0.4% (1.5% annual rate) in the third quarter after five consecutive quarterly declines.
Among the four largest economies in the Euro-zone, export-driven Germany and Italy posted healthy
increases (albeit after big declines), consumer-driven France a smaller increase (after a smaller decline),
and housing-bubble-affected Spain another
Industrial Production
decline. Recovery is much stronger in Asia.
Seasonally Adjusted, 2007-2008 Peak = 100
130 Real GDP in Japan rose a surprisingly strong
130 Total industrial production in China, manufacturing elsewhere.
120 1.2% (4.8% annual rate) in the third quarter.
120 *Data seasonally adjusted by this office.
Exports, particularly exports to China,
China*
110
110
India*
contributed heavily to Japanese growth.
Korea
100 China, along with many other Asian countries,
100
is growing rapidly again. Industrial production
90
90
was up 16.1% from year-earlier levels in
US
October. Real GDP in South Korea, one of the
EU
80
80
Japan
few countries in the region that publishes
seasonally adjusted data, rose at a 12.3%
70
70
annualized rate in the third quarter; Korea has
Taiwan*
already fully recovered from the recession in
ip2005
60
60
terms of both GDP and industrial production.
2008
2009
If U.S. businesses react to productivity-driven increases in profits and reductions in unit labor
costs the way they have in most past recoveries, employment could begin to grow sooner than many
forecasters expect, and at a faster pace. This could promote a virtuous cycle where rising employment
and labor income boost consumer spending, which leads to increased production and ultimately to more
hiring and higher incomes. However, if businesses remain reluctant to hire for too long, either because
of earnings pressures or because deficits, healthcare reform, and climate change legislation raise the
specter of future tax/cost increases, the recovery could fade in the middle of
next year. In particular, uncertainty about the impact of healthcare reform
will cause employers to hold off on hiring until the debate reaches a
conclusion. What is certain is that a recovery cannot remain “jobless”
forever; either job growth will resume or the recovery will come to an end.
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