Checking on Productivity

Eakinomics: State of Confusion Productivity lies at the heart of many important economic policy issues. Over the long term, productivity growth is central to raising the standard of living. Productivity growth permits workers to earn higher real wages and live better.   In the near term, productivity growth is one aspect of the kind of supply expansion that reduces inflationary pressure. If productivity rises, firms can pay their workers more without the pressure to pass along the cost in the form of higher prices.   For both these reasons, strong productivity growth is unalloyed good news. With that in mind, consider the chart (below) that shows year-over-year growth in labor productivity – specifically the average of the previous four quarters for each quarter since 2018. As a reflection of the then-hot labor market, productivity growth rose steadily from roughly 1.25 percent to over 2 percent by the end of 2019. The arrival of the pandemic dented productivity growth in the first two quarters of 2021, but faster productivity growth ensued each quarter for the next year. Improvements in productivity growth tailed off in the final two quarters of 2021.    A flavor of the importance of productivity growth is shown in the next chart, which displays two scenarios for unit labor costs. The first, shown in blue, is the path of actual unit labor costs (again, year-over-year and smoothed) since the first quarter of 2018.  Unit labor costs grew steadily faster from the second half of 2021 into 2022. Indeed, unit labor costs jumped from growing at roughly a 2 percent rate to growing at over a 4 percent rate and remain in that rough range. This coincides with the rise in inflation pressures. Consider the second scenario, however, which shows unit labor cost growth assuming the productivity growth is zero. Without productivity growth pushing up the number of units, unit labor costs rise much, much faster – as much as 3 percentage points faster. These cost pressures would translate into corresponding consumer price inflation pressures.   At this juncture, it is worth noting for the record that productivity growth is devilishly difficult to measure. Consider Eakinomics. Measured by the number per week (5 per week), productivity is unchanging. But perhaps one should measure by the number of words? Or graphs? If so, productivity can both rise and fall. Alternatively, perhaps the key is to measure the quality of Eakinomics. That would show ever-rising productivity, right? Putting aside these difficulties in getting productivity growth exactly right, the Biden Administration has benefitted from solid productivity growth, which has prevented inflation pressures from being even greater.