MainStreet Macro: Time well spent

Something happened last quarter that most economy watchers missed.  Labor productivity as measured by output per worker dropped like a rock. 

Being a Midwesterner at heart, I think of productivity in simple, straightforward terms. It’s about being able to do more with less. Or, in other words, produce more goods and services in less time. To put it even more directly, productivity is a measure of the economic value of time.

In the first quarter of this year, U.S. labor force time was not well spent. Productivity fell by 7.3 percent, the biggest drop since 1947. People worked 2.3 percent more hours and produced 5.4 percent less output.

As a consequence, the cost of labor became more expensive in the first  three months of the year. The cost of a unit of output increased by a whopping 12.6 percent. Employers paid 4.4 percent more per hour for less output.

Last week we got a whopper of a jobs report, with 528,000 jobs created in July, more than the approximately 400,000 average posted over the preceding three months. From the perspective of this report, the U.S. economy isn’t even thinking about recession.

But embedded in the report are signs that the labor supply is weakening, with fewer workers participating in the labor force in July than in June. All those sidelined workers helped drive the unemployment rate to a 50-year low of 3.5 percent, from 3.6 percent the previous month.

With employer demand still strong and worker supply shrinking, wages rose 5 percent from the previous month. If wages continue to accelerate, the Federal Reserve could have a tougher time reining in inflation as employers attempt to boost prices to cover higher labor costs.

On Tuesday, we’ll get a fresh read on productivity in the second quarter.  There are three reasons we should pay attention.

Low productivity leads to more inflation. Slower productivity causes employers to increase prices in order to cover rising costs. All those price increases add up to higher inflation.

Low productivity leads to lower wage growth. Wages grow when workers are more productive and business profits grow.  As productivity weakens, wage growth does, too, eventually leading to lower levels of output and weaker profits.

Low productivity leads to slower economic growth. Not surprisingly, paying more and earning less causes people to buy fewer goods and services. Because consumer spending makes up the bulk of the economy, a decline in spending causes the economy to slow.

My Take:

The good news is that all these trends work in reverse, too. A more productive labor market produces lower inflation, higher wage growth, fatter profits, and a stronger economy.

And there’s even more good news. Centuries of economic activity and output have taught us how to be more productive. Productivity can be enhanced by investment, a better educated and skilled workforce, and innovation. 

While the Fed will work hard to drive down inflation in the short run by raising interest rates, the key to the long-term health of the Main Street economy is productivity – the very definition of time well spent.