The fourth quarter’s total nonfarm productivity came in a little better than the expected rate at 1.3% (an increase of just 1.0% was anticipated). This followed a rise of 3.5% in the third quarter. Meanwhile, unit labour costs in the quarter rose by 1.7%, which was below the anticipated 1.9% reading. Remember that unit labour costs remain an incredibly volatile index and subject to fairly large revisions. On a 12-month rate-of-change basis, productivity was just 1.0%, versus a 0.1% reading in the previous quarter. Manufacturing productivity was 0.4% higher, against a 2.2% rise in unit labour costs.
This was another quarter of fairly weak productivity growth, with the 0.2% average annual increase in 2016 being the slowest pace of expansion since 2011. Unit labor costs, meanwhile, also seem to have lost a little of their momentum in the past quarter after having reached 3.1% in second quarter 2016. In the last two economic expansions, unit labour costs have generally not risen much above 3% for an extended period. This weakness in productivity and the slowdown in labour-force growth are key reasons behind the moderation in economic growth we have been witness to over the last decade. While it does not seem as though the demographic side of the equation is going to improve any time soon, particularly if measures are put in place to limit immigration and trade, we think there is some room for optimism on the productivity side, which is the topic of our Economics Weekly, due to be published tomorrow. From the Fed’s perspective, weaker economic growth suggests that it can be less forgiving for any given level of inflation or compensation growth. As it stands, the base-case scenario the Fed seems willing to tolerate would be a 1% rate of productivity growth against a 3% rise in compensation, resulting in it hitting its 2% inflation target.
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Richard de Chazal, CFA is a London-based macroeconomist covering the U.S. economy and financial markets.