Business

What Labor Productivity and Costs Mean for Employment

By Daniel Indiviglio

Labor productivity grew by another 6.9%, while labor costs fell by 5.9% in the fourth quarter, according to the Bureau of Labor Statistics. With output increasing but unemployment still high, this news shouldn't be shocking. But it does provide some indication that employers may be at a breaking point in terms of how much effort they can squeeze out of workers. What does today's data mean for employment?

Labor Productivity

BLS measures labor productivity simply as output divided by hours worked. Historically, productivity has increased more often than not. So the fact that it's increasing is usually generally seen as a good sign: more productive workers are good for an economy. But in a recession, it increases further for another reason -- employers are demanding nearly the same amount of output from fewer workers. Here's a chart showing labor productivity since 1947, as far as BLS's data goes back:

productivity 10-03 - 1.PNG

I created this graph by doing a ratio of BLS's indices of labor output and hours worked. As you can see, it's a relatively steady upward trend. But since the start of 2009, the slope of the curve has become quite steep. In fact, the rise in productivity in 2009 was the largest for a year since 1965.

So the bad news is that employers are getting more work out of fewer workers, rather than hiring. But the good news is that this behavior can only be sustained for so long. There are limits to how productive workers can be, so eventually employers will have no choice but to hire more as output continues to increase. Here's another graph I made that shows unemployment and quarterly productivity growth since 1970:

productivity 10-03 - 2.PNG

You can see that the peaks in unemployment tend to coincide with the peaks in productivity. And it's pretty hard to see any unemployment peaks that don't also begin to decline as the productivity growth declines. Since productivity growth was less in Q4 than Q3, I would see this as a good sign for unemployment, based on this chart.

Labor Costs

BLS defines labor costs as the ratio of hourly compensation to labor productivity. So another sort of obvious phenomenon is that labor costs will decline for employers when productivity is increasing. In fact, they've decreased dramatically since the start of 2009. This chart shows labor costs with the index starting at 1 in 1947:

productivity 10-03 - 3.PNG


That recent recession caused the most dramatic decline in labor costs shown for a year in 2009 -- they declined by 17.3%. Again, that's the biggest decline in labor costs for a year since 1947. The good news here is that lower labor costs should make it easier to hire. As you can see, they're now back at 2006 levels.

So today's data is sort of bittersweet. Even though employers are managing to increase output without hiring, they can probably only do that for so long. And if history is any indication, some real employment growth shouldn't be too far off.

(Image Credit: Wikimedia Commons)