Sluggish Labor Productivity
The US economy continued its slow growth trajectory during the first quarter with the first reading of GDP showing only 0.5% growth. One factor in keeping growth subdued is low labor productivity - the output of goods and services for each hour of labor. As the chart below shows, the 5 year growth rate in labor productivity has dropped to levels last seen more than 30 years ago.
Sharp Slowdown in Productivity Growth: Real Nonfarm Business Productivity
Another way to view the same issue is to look at the cumulative real output per hour of all workers. In the chart below, the slope of the line changed after the financial crisis and has grown at a slower trajectory over the last 5 years.
Nonfarm Business Sector: Real Output Per Hour of All Persons
And finally, another way to view productivity is to review average growth in real output per
worker over 10 year time frames, as illustrated here in this table.
y Has Productivity Slowed?
There are many theories on why productivity has slowed, including the inability to measure productivity accurately in our current economy, decreased competition in more concentrated industries, decreased investment in worker skills, and decreased economic impact of innovations, to name a few.
However, the most likely explanation, in my opinion, is decreased capital spending by companies due to slow economic growth and increased uncertainty. Business leaders invest for the future when they have a high degree of confidence that their investments will generate a solid return, and this confidence is tough to find in our slow growth economy.
One positive aspect of slow productivity over recent years has been increased employment, as businesses invested in labor. Employees were relatively inexpensive due to high unemployment. Businesses can also cut employees during a downturn as opposed to the more permanent commitment of purchasing capital equipment.
Revisiting Wage Growth
I wrote in the December 2015 edition of Providence Perspectives that wage growth may begin to emerge during 2016. We are far from conclusive wage growth, but hourly compensation increased at a 3.0% annual rate during the first quarter as compared to the previous quarter. This compares to a 0.9% growth rate from the third to fourth quarter during 2015.
Growth & Economic Rebound
I believe the most likely scenario in the near future is that we continue our current slow growth trajectory, however wage growth may provide a catalyst to better economic growth. If employees boost consumption with their increased earnings, economic growth will accelerate. At the same time, increased cost of labor may incent businesses to invest in capital equipment, thereby boosting productivity and further accelerating economic growth.
The economic rebound since the financial crisis has been slow and uneven, and there are countless factors, both domestic and international, that could keep the above scenario from unfolding. During the last 7 years, the economy has not managed to reach "escape velocity" which creates a virtuous circle of economic growth. Perhaps, just perhaps, increased wages followed by business investment will create the necessary spark.