The Big Idea
Q3 Productivity and Labor Costs
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Nonfarm business productivity growth for Q3 was unrevised at 2.2% annualized, reflecting the steady output figure for the period. There has been considerable talk, including from several Fed officials, that productivity growth has likely accelerated on a trend basis. I am not ready to sign off on that conclusion just yet. The “trend” depends very much on how you slice the data. Efficiency gains have been robust over the past six quarters, rising by more than 2% annualized in 5 of the last 6 quarters. The Q4/Q4 gain last year was 2.7%, which would be a sharp uptick. However, as I have pointed out many times, the productivity data are notoriously erratic, and the best way to consider them is on a multi-year basis. That is especially true in this case because, while productivity growth was robust in 2023, the prior year, 2022, was the worst in decades (-1.3% on a Q4/Q4 basis). Moreover, the data have been even more erratic in recent years than usual because GDP growth and the labor market were out of phase for much of the post-pandemic period, distorting the productivity numbers. So, I would argue that the best way to think about the trend is to look at productivity gains since the beginning of 2020. Using that filter, productivity growth over the last five years has averaged 1.9%. That is exactly the same as the average over the 2017-to-2019 period.
Having said that, it is worth noting that the 2017-2019 performance constituted a significant acceleration from the 0.8% average for the period 2011 through 2016. What changed? I would argue that productivity gains picked up at least in part because government policy shifted to a more investment-friendly stance in the form of substantial tax cuts, especially on corporate and investment income, as well as a looser regulatory framework. That dynamic could repeat itself over the next few years, though at this point, nothing is guaranteed. The surge reported today in the November NFIB small business survey gauge bolsters the view that firms are hopeful that a friendlier policy mix will boost the economy.
Unit labor costs were marked downward in both Q2 and Q3, mainly reflecting the benchmark revisions to Q2 employment and wages data. Labor income growth for Q2 was slashed, and, reflecting the change, the unit labor costs figure for the period was cut all the way from +2.4% annualized to a 1.1% slide. Similarly, labor income for Q3 was also revised lower, by 1.2 percentage points. This adjustment fed through to unit labor costs, which were trimmed from 1.9% to 0.8%. Since the beginning of last year, unit labor costs have risen at an annual pace of just above 2%, which is consistent with the argument being made by a number of Fed officials that the labor market is no longer a significant source of upside pressure on inflation.
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