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Chapter 17
Labor
Productivity:
Wages, Prices,
and Employment
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McGraw-Hill/Irwin
Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved.
17-2
1. The Productivity
Concept
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17-3
Labor Productivity
Labor Productivity =
Total product (real GDP)
Number of worker hours
Productivity can be calculated using data from different years
to form an index of productivity relative to a base year.
Productivity =
IndexYear 2
ProductivityYear 2
ProductivityBase Year
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* 100
17-4
• The BLS productivity
index is calculated by
dividing real output in
the private sector by the
number of hours
employed in the private
sector.
• The index understates
productivity growth in
that improvements in the
quality of output are not
taken into account.
• The index implies that
labor alone is the cause
of the rise in
productivity. Other
factors such as increases
in the amount of capital
and technological
progress also play a role.
Output Per Worker
BLS Index
160
140
120
100
80
60
40
20
0
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005
Index
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17-5
2. Importance of
Productivity Increases
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17-6
Importance of Productivity
Increases
 Productivity increases are important
because:
 Productivity growth is the basic source of
increases in real wages and living
standards.
 Productivity growth is an anti-inflationary
force in that it offsets increases in
nominal wages.
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Productivity and Real
Compensation
• Because real output is
real income, the
growth of real output
per worker hour and
the growth of real
compensation per hour
are very closely
related.
Index (1992=100)
17-7
160
140
120
100
80
60
40
20
0
1947
1957
1967
Output per hour
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1977
1987
1997
Real hourly compensation
17-8
Inflation and Productivity
 If nominal wages rise at a faster rate than
productivity rises, then the labor cost per
unit of output (unit labor cost) will rise.
 If nominal wages rise at a slower rate
than productivity rises, then the labor cost
per unit of output will fall.
 Since labor costs are between 70 and 75
percent of total production costs, higher
unit labor costs will lead to higher
inflation.
 Other factors also affect the inflation rate
such as the money supply.
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17-9
3. Long-Run Trend of
Labor Productivity
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17-10
Importance of Causes
of Productivity Growth
• Jorgenson and Stiroh
estimate that about
one-half of the
productivity growth
over the 1959-2004
period was due to
increases in the
quantity of capital.
The other half was due
to increases in labor
quality and
improvements in
efficiency.
33%
53%
14%
Increased Efficiency
Quantity of Capital
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Improved Labor Quality
17-11
Increases in Educational
Attainment
100%
80%
Percent
• One reason that labor
quality has increased
is that the educational
attainment of the
population (aged 25
and older) has
increased over time.
60%
40%
20%
0%
1960
1970
1980
1990
2005
Percent High School Graduate or More
Percent College Graduate or More
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17-12
Increased Quantity
of Capital
 A higher amount capital increases labor
productivity.
 For example, one can dig more dirt per
hour with a bulldozer than with a shovel.
 Between 1959 and 1998, the amount of
capital per worker hour went up by about
50 percent.
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17-13
Increased Efficiency
 Increased efficiency can result from
 Technological progress including
improved capital and business
organization and managerial techniques.
 Greater specialization as the result of
scale economies.
 Reallocation of labor from less productive
to more productive sectors.
 Changes in the legal, environmental
conditions, public policy
 For example, lower trade barriers.
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17-14
4. Cyclical Changes
in Productivity
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17-15
Business Cycle
and Productivity
 Labor productivity is procyclical.
 Productivity rises in economic booms and
falls during recessions.
 Productivity is procyclical because
 In a recession, a firm’s sales decline more
rapidly than its units of labor
 Some managers are a fixed cost of labor
 Firms are reluctant to fire workers with
specific training since they lose their
training investment.
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17-16
Business Cycle
and Productivity
 Capital is not fully utilized during
recessions and so productivity falls.
 During recessions, demand falls the most
in the high productivity durable
manufacturing goods sector.
 The share of manufactured goods in total
output falls, and so productivity falls
during recessions.
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17-17
Implications
 The fall in productivity during recessions
makes them more severe.
 The productivity decline raises unit labor
costs, which lowers profits.
 Lower profits decrease investment
spending which intensifies the downturn.
 The reverse occurs during economic
recoveries.
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17-18
Implications
 Cyclical changes in productivity also
have implications for economic policy.
 Declines in productivity contribute to
cost-push inflation by raises unit labor
costs.
 A cyclical rise in productivity during the
early stages of a recovery permits more
expansionary policy since it lowers unit
labor costs.
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17-19
Question for Thought
1. Describe and explain the cyclical changes that
occur in labor productivity. Of what significance
are these changes?
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17-20
5. Productivity and
Employment
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17-21
Demand Factors Constant
 Compensation rises more or less evenly
across industries, even though output per
hour varies greatly by industry.
 Labor supply shifts prevent wages from
diverging in the various industries.
 This implies rising per unit costs and
reduced output and employment in
industries with slow productivity growth,
and falling per unit costs and output and
employment in industries with high
productivity growth.
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Productivity and
Employment, 1994-2004
• Variable demand
factors confound the
actual relationship
between productivity
growth and
employment within
industries.
• The data reveal no
systematic relationship
between industry
productivity growth
and industry
employment growth.
Employment (annual percent change)
17-22
20
15
10
5
0
-5
-15
-10
-5
0
5
Productivity (annual percent change)
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10
15
17-23
Question for Thought
1. How do you account for the close correlation
between changes in the rate of productivity
growth and changes in the real wage rates for the
economy as a whole? Does this relationship also
hold true on an industry-by-industry basis?
Explain.
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17-24
6. The “New Economy”
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Labor Productivity
Growth Rates, 1948-2006
• Productivity growth
surged in the second
half of the 1990s, after
being relatively low
for the prior two
decades.
• No consensus exists as
to whether this
increase in the
productivity growth
rate is a part of a new
long-run trend or
simply a temporary
aberration.
3.5
3
2.5
Percent
17-25
2
1.5
1
0.5
0
1948-1973 1974-1990 1991-1995 1996-2006
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17-26
Use of Information Capital
 Increased use of information capital
 Faster increases in the quantity of
information such as computers may have
increased productivity growth.
 Jorgenson, Ho, and Stroh's analysis
indicates 33 percent of the acceleration in
productivity growth between 1973-95 and
1996-2004 was due to increases in the use
of information technology
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17-27
Technological Progress
and Efficiency
 Technological progress and efficiency,
particularly in information technology,
may have increased the productivity
growth rate.
 Jorgenson, Ho, and Stiroh find that 18
percent of the productivity speedup
starting in the second half of the 1990s
was due to increased efficiency in the
production of information technology
products.
 Another 40 percent was caused by
technological progress and efficiency
gains in the rest of the economy.
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17-28
End
Chapter 17
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