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Chapter 17 Labor Productivity: Wages, Prices, and Employment Next page McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. 17-2 1. The Productivity Concept Jump to first page 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 Jump to first page * 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 Jump to first page 17-5 2. Importance of Productivity Increases Jump to first page 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. Jump to first page 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 Jump to first page 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. Jump to first page 17-9 3. Long-Run Trend of Labor Productivity Jump to first page 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 Jump to first page 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 Jump to first page 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. Jump to first page 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. Jump to first page 17-14 4. Cyclical Changes in Productivity Jump to first page 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. Jump to first page 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. Jump to first page 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. Jump to first page 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. Jump to first page 17-19 Question for Thought 1. Describe and explain the cyclical changes that occur in labor productivity. Of what significance are these changes? Jump to first page 17-20 5. Productivity and Employment Jump to first page 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. Jump to first page 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) Jump to first page 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. Jump to first page 17-24 6. The “New Economy” Jump to first page 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 Jump to first page 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 Jump to first page 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. Jump to first page 17-28 End Chapter 17 Jump to first page