The fourth quarter’s total nonfarm productivity came in lower than expected at -3.0% (-2.0% was anticipated). Meanwhile, unit labour costs in the quarter were a little above what was anticipated at 4.5% (highest since Q4 2014), where a reading of 4.3% was expected. Unit labour costs remain an incredibly volatile index and subject to fairly large revisions (e.g., the first quarter was revised from 6.7% to 2.6%), hence any near-term changes here should be taken with a pinch of salt. On a 12-month rate-of-change basis, productivity rose by 0.3%, versus 0.6% in the previous quarter, while manufacturing productivity was a little better, in that it only fell by 0.4% in the fourth quarter after rising 5.0% in the third quarter and 1.5% higher than a year ago. Unit labour costs for this sector rose by 3.6%, after a 2.3% increase in the third quarter. On a 12-month rate-of-change basis, unit labour costs were 1.9% for manufacturing and 2.8% higher for nonfarm business.
An economy’s potential rate of GDP growth is roughly made up of growth in the workforce, growth in total factory productivity, and growth in the capital stock. With the capital stock growing only very slowly and demographics holding back the workforce (in addition to possibly some skills mismatch), productivity remains one of the key ingredients boosting economic potential. It is also something of a wildcard, with views ranging from innovation being dead to being at the start of a “second machine age” brought on by the massive leaps we have made in connectivity. There is also a school of thought suggesting that the current statistics do not accurately account for potentially huge productivity gains in the services sector, in part because of the inability of the inflation gauges to accurately adjust for quality improvements. We remain generally optimistic here, but the main downside—judging from the continued softness in unit labour costs—has been that the worker does not seem to be reaping much of these gains. Weak growth in compensation remains a key issue for the economy and one of the main factors holding back current economic growth and potential growth. This past quarter’s is helpful as long as it does not put too much pressure on corporate profit margins to the extent that it prompts layoffs. The Fed is also a little concerned that weaker productivity growth means the economy is bumping up against its capacity constrains much sooner than would have been the case in the past, which would raise the inflation threat. The financial markets still believe there is enough slack.
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Richard de Chazal, CFA is a London-based macroeconomist covering the U.S. economy and financial markets.