Strong post-recession gain in productivity contributes to slow growth in labor costs Essay

How do changes in productivity and costs during the current economic
recovery compare with earlier ones? Does the six-quarter recovery
reflect a resurgence of the higher pre-1973 trend in the growth of
output per hour?

Although postwar recessions have differed in length and severity,
movements of productivity and cost measures follow a common pattern.
Generally, employers tend to delay trimming payrolls in the face of
uncertain or slack demand in order to postpone the costs associated with
layoffs until the nature of weak demand becomes apparent. The resulting
delayed cutback in hours contributes to the initial drop in
productivity. If a contraction persists, average weekly hours are
initially reduced. Eventually, employment cuts also occur, and
productivity may actually increase if the belated declines in hours
outstrip the fal in output.

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At the trough of the business cycle, capacity utilization is low,
with plant and equipment operating below optimum or design rates because
of weak demand for output. Inefficient plants and equipment may be
idled completely as demand may be met using only the newest, most
efficient facilities. Workers who have been retained may also perform
deferred maintenance or other duties previously handled by laid-off
coworkers. However, these “hoarded” employees may be those
with the greatest seniority, experience, and training specific to the
firm(s needs, making them the most costly to replace.

When demand begins to revive, output can often be boosted without
causing commensurate increases in the payroll. Firms respond by using
some idle plants and equipment and by redirecting existing labor to
production-related tasks. This results int he rapid productivity gains
which have characterized the immediate posttrough period of each postwar
recovery. The “productivity dividend” continues as long as
output gains exceed additions to paid hours.

Employers tend to accommodate growing demand by initially
lengthening the workweek. But as the uptrend continues, furloughed
workers return and hiring may begin. The pace of productivity growth
slackens as hours increase, and when new workers are hired, trained, and
assimilated. The least efficient plants are reopened last. Periods of

During the six quarters since November 1982 (the trough of the last
recession), output per hour int he nonfarm and manufacturing sectors
grew more than the postwar average trend. A period of faster-than-trend
productivity growth also occurred after each of the seven previous
postwar recession troughs. Nonfarm productivity growth averaged 2.5
percent per year between 1947 and 1973. In the siz quarters following
the trough of the five recessions, growth was nearly half again as fast
(at an annual rate). The following tabulation compares the productivity
trend with recovery growth rates before and after 1973:

After 1973, the long-term trend in productivity growth slowed in
the nonfarm sector. During 1973-83, the average 1984-73. However,
productivity advances during the six posttrough quarters slowed much
less than the overall trend. As indicated, during the first five
recoveries, productivity grew at a 3.6-percent annual rate during the
first six quarters after the trough. Since 1973, we have experienced
three additional recoveries, during which productivity advances averaged
3.4 percent per year. The reduction in the pace of productivity growth
during recoveries after 1973 was smaller than the slowdown of the
long-term trend. Thus, productivity increased during the pre-1973
recovereies at 1.4 times the long-term rate; after 1973, the recoveries
averaged four times the slower trend which characterized the last

The manufacturing sector–which is much smaller than the nonfarm
business sector–tends to be more volatile. As in the nonfarm business
sector, the trend also slowed; between 1984-73 and 1973-83 the average
annaul rate of productivity growth declined from 2.9 to 1.8 percent.
But in contrast to the more comprehensive nonfarm business sector, the
gains in the recovery period have been larger since 1973. In the first
five recoveries, productivity advances averaged 4.8 percent annually; in
the three most recent rebounds they averaged 5.7 percent and the most
recent recovery showed gains at a 4.5-percent annual rate.

The highest nonfarm productivity growth occurred after the three
troughs when output per hour advanced at a 4.1-percent annual rate. The
smallest posttrough gain occurred following the 1980 trough. (See table

From the standpoint of productivity advance, the current recovery
is somewhat stronger than the average of similar stages of recovery in
the nonfarm sector and weaker than average in manufacturing. Chart 1
compares movements in productivity and related measures in this recovery
with the average of the previous seven recovery periods in the nonfarm
and manufacturing sectors.

In the six posttrough quarters, nonfarm output has increased at an
average annual rate of 7.0 percent in the previous cycles, but the
advance after the most recent trough has been faster–9.8 percent. Hours
have also rebounded from the trough level more rapidly than during past

Table 1 shows the annuals rates of change in output, hours, and
related measures. Manufacturing output and hours also advanced more
rapidly in this recovery, although the rate of productivity gain is
smaller than average.

Hourly compensation increases during the present recovery have been
smaller than during earlier upturns. This measure, which includes wages
and salaries, supplements, and employer payments to all employee benefit
plans, represents the largest cost to most producers. In the seven
previous recoveries, hourly compensation increased at a 6.4-percent
annual rate in the nonfarm business sector, while in the present
recovery, the increase was 4.2 percent over the six quarters. Moreover,
in recent recovery periods, hourly compensation advances have approached
10 percent in the six quarters following the trough. (See tables 2 and
3.) Thus, the slower gain in hourly compensation, coupled with the
productivity increase, resulted in a small rise in unit labor costs
(compensation per unit of output) for the nonfarm sector. Nonfarm unit
labor costs ros at a 0.2-percent annual rate in the six quarters after
the trough; in the preceding recovery (after the 1980 trough) these
costs rose 7.4 percent in just four quarters.

In manufacturing, hourly compensation increased at a 3.0-percent
rate over the six quarters of the recovery, compared with an average
rate of gain of 6.2 percent during previous recoveries. This slower
increase, combined with the advances in labor productivity, resulted in
a 1.5-percent rate of decline in unit labor costs. In past recoveries,
these costs rose somewhat over the like period.

Because labor compensation is such an important part of total
costs, the more favorable performance of unit labor costs during the
current recovery means less upward pressure on prices. This also allows
for noninflationary growth of profits and nonlabor cost items, which can
be a source of business saving and investment.

Quarterly measures of profits and profits per unit of output are
only available since 1958 and only for the nonfinancial corporate
sector. The following tabulation shows the average annual rate of
change (in percent) in profits in the six posttrough quarters for the
sector. (Third-quarter 1980 shows the change in just four posttrough

The very large increase in total corporate profits and in profits
per unit of output partly reflects the downturn in unit labor costs
during the current recovery. Unit labor costs declined 0.2 percent in
the six quarters after the 1982 trough, compared with an increase of 7.0
percent in just four quarters after the July 1980 trough. This
contributed to the very different performance of profits in these two
cycles. Periods of contraction

In response to major cyclical contractions in the demand for goods
and services, output, employment, productivity, and prices all diverge from long-term trends. Little can be inferred about the divergence in
productivity from the length of the recession alone. Two of the earlier
contractions (1948-49 and 1969-70) lasted 11 months; in one case,
productivity growth slowed to 0.6 percent in the nonfarm sector, and in
the other it grew 1.1 percent. (See table 4.) Two contractions
(1952-53 and 1960-61) lasted 10 months; int he former, productivity was
unchanged, while int he latter it rose 0.7 percent. Two contractions
(1957-58 and 1980) lasted less than 10 months; in the former,
productivity rose 1.7 percent during the downturn, and in the latter, it
declined 0.2 percent. There was only one other contraction (1973-75)
that lasted as long as the 1981-82 downturn and while in the most recent
case productivity declined 0.3 percent, in the earlier instance, it fell
2.6 percent during the 16-month period. Growth of output per hour of
all persons in nonfarm business either slowed or ceased in the first ive
postwar business cycles, but following the peaks in 1973 and 1980,
productivity actually declined during the contraction.

As noted, three have been eight business cycle contractions since
World War II. The most recent contraction began in July 1981 and ended
in November 1982, 16 months later. We have seen that only the 1973-75
contraction lasted as long; on average, the upturn has come 10 months
after the peak of the business cycle. Nonfarm business output declined
more during 1981-82 than the average of previous contractions, and the
cutbacks in hours and employment were also severe. Hours were reduced
in four of the five quarters following the onset of the 1981-82
contraction. Nonfarm employment had not been cut as sharply since the
late 1950’s, and manufacturing employment fell a record
amount–10.2 percent. This situation may be partly explained by the
fact that there was a relatively short interval between this contraction
and the previous one–only 12 months–and employers did not maintain
employment because demand was falling again. In addition, the period of
rapid growth of hourly compensation carried over into the downturn,
which made labor “hoarding” increasing expensive. Both
nonfarm hourly compensation and unit labor costs rose almost twice as
much during the 1981-82 downturn as during the average contraction.
Hourly compensation also advanced rapidly in manufacturing during the

Unit labor costs (compensation per unit of output) are affected by
changes in productivity (output per hour) and compensation per hour. If
productivity and hourly compensation change equally, unit labor costs
are unaffected. Chart 2 shows the relationship between these series
since 1973. Declines in productivity during postwar contractions are
thus related to periods of rapid increases in unit labor costs.

Contrasting trends were evident in manufacturing. While
productivity grew modestly in durables as large increases occurred in
both output and hours, a more rapid productivity gain was experienced in
nondurable goods manufacturing, where increases in output and hours were
not as robust. As a result, unit labor costs declined more in
nondurables. There is also a significant difference between the
second-quarter productivity advance in nonfarm business (5.5 percent)
and that for nonfinancial corporations (2.8 percent), which account for
more than 75 percent of nonfarm business output. Most of this
difference can be explained by the larger rate of increase of hours in
the nonfinancial corporate sector than in nonfarm business, which
includes the self-employed and financial activities.

The following tabulation shows the percent changes at annual rates
in productivity, output, and hours for the second quarter of 1984:

Compensation and labor costs. Compensation per hour of all persons
engaged in the nonfarm business sector rose at a 3.7-percent annual rate
in second-quarter 1984, but remained unchnaged after allowing for the
increase in the Consumer Price Index for All Urban Consumers (CPI–U).
Unit labor costs declined 1.7 percent in the second quarter, compared
with a 3.1-percent annual rate of increase in the first quarer.

In manufacturing, hourly compensation increased at a 2.9-percent
annual rate in the second quarter (or fell 0.8 percent after allowing
for the increase in the CPI–U), and unit labor costs declined 1.1

Employment and hours. Labor input used in BLS productivity
measures is hours of paid labor time. Adjustments to labor input in
response to changes in demand can be accomplished through changes in the
workweek as well as changes in employment. In the nonfarm business
sector, employment maintained the high growth rate of the first quarter,
while average weekly hours decelerated in the second quarter. this
market the sixth consecutive quarter of increasing average weekly hours,
the longest period of such growth in the series. Employment growth
slowed, and the workweek was shortened somewhat in manufacturing in the
second quarter.


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