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Investment Management
Economic and Financial Market
Commentary
February 21, 2014
Behold!
Once again, weather is clouding the economic outlook. We won’t know for several months whether there is a true
economic slowdown underway, or if consumption and production measures have been primarily depressed by an
abnormally harsh winter in many parts of the country. (Ask any grumpy New Yorker and you will get a resounding
yes!)
But there is a more important story unfolding which is quite positive for the U.S. economy. Productivity growth
has bounced back closer to a more normal 2% growth rate after three years (2010-12) of sub-par growth of <1%.
It is a development to behold, as this rebound has profound implications for prospective economic growth,
inflation, and monetary policy.
Y-O-Y %
Productivity Growth On the Rise Again
Annualized Average Productivity Growth
7
6
50-Year
2.0%
5
25-Year
2.2%
3
10-Year
1.7%
2
5-Year
2.1%
3-Year
1.0%
1-Year
1.7%
4
1
0
-1
88
93
Sources: Bloomberg and BBH Analysis
98
03
08
13
Sources: Bloomberg and BBH Analysis
Let’s return to Economics 101 for a moment. Recall that the growth of any economy can only be derived from
more labor or capital inputs and improved productivity. A factory can only make more widgets if it has more
workers making widgets, and/or if its workers become more productive. The same is true for any economy in the
world. For most developed and many developing economies (like China), labor force growth has been challenged
by decades of declining birth rates, and so most of what drives economic growth is productivity advancements.
You can also think of productivity growth as the means by which societies advance their standards of living. The
translation of changes in productivity growth to changes in standards of living is exponential, not linear. An
example below illustrates the power and importance of small changes in productivity growth.
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Economic and Financial Market Commentary / February 21, 2014
Rising Standard of Living
Some investors are familiar with the “Rule of 72”,
The Power of the Rule of ‘72
100%
which is a handy way to calculate how long it takes to
72 Years
1%
double your money at a given rate of return (e.g.,
36 Years
75%
2%
9 years to double your money at an 8% annual return,
24 Years
3%
or 18 years to double your money at a 4% annual
18 Years
50%
4%
return). The “Rule of 72” framework can also be used
9 Years
to determine how long it takes for a society to double
8%
25%
its standard of living. At a 2% rate of productivity
growth (as evidenced over time in the U.S.), it takes
0%
0
10
20
30
40
50
60
70
80
36 years to double a country’s standard of living. At
Years
For illustrative purposes only
Source: BBH Analysis
1.0% rate of productivity growth (as evidenced in
Japan and Western Europe), it takes 72 years to double a country’s standard of living. Finally, at a 10% rate of
productivity growth (as evidenced in China over the past decade), it takes only 7 years to double a country’s
standard of living. Small changes in productivity over the long term bring profound changes within an economy.
Of course, there can sometimes be a dark side to faster productivity – slower growth in employment. If companies
can achieve their growth objectives through higher productivity (e.g. efficiency gains and incremental investment),
they may not choose to add labor to achieve higher output. This may partially explain the still-anemic labor
market gains evidenced in the U.S. over the past five years where productivity growth has averaged 2.1%. But
there have also been other periods – 1995-2000 – where higher productivity growth went hand-in-hand with faster
employment growth. The latter did put pressure on wages, but this pressure was offset by higher productivity
leaving Unit Labor Costs, the key driver of broader inflation pressures in the economy, well behaved.
Unit Labor Costs Not a Threat As Productivity Rebounds
Annualized Average Unit Labor Costs Change
Y-O-Y %
6
50-Year
3.1%
25-Year
1.4%
0
10-Year
1.1%
-2
5-Year
-0.2%
-4
3-Year
1.2%
1-Year
-1.3%
4
2
-6
88
93
Sources: Bloomberg and BBH Analysis
98
03
08
13
Sources: Bloomberg and BBH Analysis
All else equal, the faster is productivity growth, the slower are Unit Labor Costs and the better controlled is
inflation. Fed policymakers dream of an environment of robust economic growth driven by robust productivity
gains, as this tends to restrain advances in labor costs, and overall inflation. No one would describe today’s
environment as robust, but even moderate economic growth, driven mostly by decent advances in productivity, are
surely limiting the growth in employment, limiting the growth in worker compensation, and ultimately, limiting
the pace of inflation.
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Economic and Financial Market Commentary / February 21, 2014
The Fed wants it all – a strong economy, a strong labor market, and low inflation. Don’t we all. This trio of goals
is surely achievable if productivity growth remains solid and companies eventually decide to augment productivity
gains with more labor inputs in order to maximize their output. Time will tell if the recent rebound in productivity
growth is sustainable, but the recent trends are more promising after a concerning period of anemic advances
earlier in this expansion.
Jeffrey A. Schoenfeld
Partner
IM-2014-02-21-0963
Research: Jorge Aseff
Production: Brian Ehrlich
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