Is it time to start worrying about poor US productivity growth?
Poor growth in labour productivity has been a defining feature of the US economic recovery since the Great Recession. While we’ve acknowledged it for some time now, that has come with a patiently optimistic outlook. If that optimism remains unrealised, it will soon be time to worry a bit more.
Latest data for the year to June 2016 shows US labour productivity growth of -0.4%. We don’t put too much weight on point estimates – over a short period of time low productivity can be explained by the fact that firms typically don’t let people go through short periods of economic weakness. That’s why we tend to look at longer-term trends. But that doesn’t make for much happier reading. Over the period since the Great Recession US labour productivity growth has averaged 1.2% per annum and just 0.7% per annum in the past three years. That compares with an average 2.5% per annum in the 10 years prior to the recession.
Why do we worry about this? Productivity is one of the key determinants of long-term economic performance. It also helps determine the pace of sustainable wage growth and inflationary pressure. A simple (but effective) model of likely future long-term growth is to sum expected growth in working age population (WAP) and productivity.
We’ve been observing and commenting on the low trend rate of US productivity ever since the recession. Concern has been tempered by the stage of the econmic cycle. While labour has been plentiful and wage growth has been benign it makes sense for firms to resource the growth in demand for their goods and services with labour rather than capital. This helps explain the equally disapointing growth in business investment since the recession.
However, it is right about NOW that we expect this dynamic to change. Standard cyclical theory tells us to expect that as an economy reaches full employment, labour becomes more difficult to find, wages rise and firms then turn to investment to resource the growth in their businesses.
The unemployment rate is now down, or at least close, to most analysts’ (including the US Federal Reserve) estimates of full employment. Recent labour market survey data suggests it is getting harder to find skilled labour. So its about now we expect business investment to rise and labour productivity to improve. At the heart of that expectation is the assumption that much of the recent weakness in labour productivity is cyclical. We have a bigger problem if it turns out to be structural.
If it doesn’t recover the theory is that firms will continue to grow earnings with cost cutting which will mean job layoffs and potential recession. I’m not that dark on the outlook, although acknowledge that is a risk. At the very least we could be about to leave the problem of the last seven years behind us (low growth, low inflation) with a new one (low growth, high(er) inflation).
That’s why the Fed is currently contemplating a critical conundrum. Weak productivity growth and a tightenng labour market are putting pressure on costs. Unit labour costs are up 2.1% over the past year and the trend is pointing to a continued trend higher in inflation that the Federal Open Market Committee won’t be able to ignore for too much longer.
Monetary policy can’t fix poor productivity. That’s why I’m famous for occasionally boring people into a stupor talking about the need for structural reform. In the US one of the key areas for reform is the overly burdensome tax system. That’s why I found myself (somewhat worryingly?!) in high level of agreement with US Presidential candidate Donald Trump this week following his tax reform speech.
Of course, low productivity isn’t just a US problem. Most major developed economies have seen relatively weak productivity growth since the Great Recession. The simple model of WAP growth plus productivity helps explains Japan’s weak trend growth rate of 0.5% and the Eurozone’s 1.5%. Structural reform is the answer there too.
Poor US productivity growth is a worry. The optimist in me says it’s just a matter of time before it starts to improve. I’ll be sure to let you know when it’s time to worry a bit more.
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