As the U.S. reaches full employment, low productivity growth may signal future problems, including higher inflation and decreased profit margins.
Productivity — the measure of economic output per unit of input — has decelerated steadily for the last decade. So why did markets collectively yawn at the news that U.S. non-farm productivity fell at a -1.0% annual rate in the first quarter? Perhaps it was because they have grown accustomed to disappointing news on productivity or because they’ve managed to thrive for so long in spite of weak productivity trends. Whatever the reason, the time for complacency has passed.
U.S. rate of productivity growth: A troubling downward trend
Two paths to long-term growth
There are two sustainable means of producing healthy, long-term, global economic growth. The first path is through a bigger labor force. More workers — a function of the employment pool and participation rate — allow an economy to produce more goods and services.
The second path is through higher productivity, when the same number of employees working the same number of hours produces more goods and services. The combination of the two is what most of us are accustomed to.
Although productivity growth in most advanced economies has been decelerating for a long time, negative productivity growth is a recent phenomenon. While there was a welcome bounce immediately following the 2008 financial crisis, this was simply a reflection of growth and output recovering from extremely depressed levels using roughly the same pool of labor. The leveling off since 2012 portrays a more structural problem.
Why is this suddenly important today? It’s because the U.S. has now reached — or is very close to reaching — full employment. An unemployment rate of 5% or less is widely recognized by policymakers and markets as a non-inflationary speed limit. This puts pressure on the U.S. Federal Reserve to tighten monetary policy or accept higher wage pressures. At the same time, it foreshadows slower growth.
Why you should care
The current economic recovery is one of the weakest on record, and productivity is to blame. Quantitative easing owes its prevalence to the disappointing productivity trends, which have in turn restrained growth. Productivity also explains the poor growth in real wages, which has restrained inflation and contributed to income inequality. The key point is this: over the last five years, growth in the U.S. and most developed economies has been driven almost entirely by the falling unemployment rate. So while people are returning to jobs, they’re not being particularly productive.
The U.S. is nearing full employment
Source: Macrobond 2016/Bloomberg 2016