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

How do changes in productivity and costs during the current economicrecovery compare with earlier ones? Does the six-quarter recoveryreflect a resurgence of the higher pre-1973 trend in the growth ofoutput 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 ofuncertain or slack demand in order to postpone the costs associated withlayoffs until the nature of weak demand becomes apparent. The resultingdelayed cutback in hours contributes to the initial drop inproductivity. If a contraction persists, average weekly hours areinitially reduced. Eventually, employment cuts also occur, andproductivity may actually increase if the belated declines in hoursoutstrip the fal in output. At the trough of the business cycle, capacity utilization is low,with plant and equipment operating below optimum or design rates becauseof weak demand for output. Inefficient plants and equipment may beidled completely as demand may be met using only the newest, mostefficient facilities. Workers who have been retained may also performdeferred maintenance or other duties previously handled by laid-offcoworkers.

However, these “hoarded” employees may be thosewith the greatest seniority, experience, and training specific to thefirm(s needs, making them the most costly to replace. When demand begins to revive, output can often be boosted withoutcausing commensurate increases in the payroll. Firms respond by usingsome idle plants and equipment and by redirecting existing labor toproduction-related tasks.

This results int he rapid productivity gainswhich have characterized the immediate posttrough period of each postwarrecovery. The “productivity dividend” continues as long asoutput gains exceed additions to paid hours. Employers tend to accommodate growing demand by initiallylengthening the workweek. But as the uptrend continues, furloughedworkers return and hiring may begin. The pace of productivity growthslackens as hours increase, and when new workers are hired, trained, andassimilated.

The least efficient plants are reopened last. Periods ofrecovery During the six quarters since November 1982 (the trough of the lastrecession), output per hour int he nonfarm and manufacturing sectorsgrew more than the postwar average trend. A period of faster-than-trendproductivity growth also occurred after each of the seven previouspostwar recession troughs. Nonfarm productivity growth averaged 2.5percent per year between 1947 and 1973. In the siz quarters followingthe trough of the five recessions, growth was nearly half again as fast(at an annual rate). The following tabulation compares the productivitytrend with recovery growth rates before and after 1973: After 1973, the long-term trend in productivity growth slowed inthe nonfarm sector.

During 1973-83, the average 1984-73. However,productivity advances during the six posttrough quarters slowed muchless than the overall trend. As indicated, during the first fiverecoveries, productivity grew at a 3.6-percent annual rate during thefirst six quarters after the trough. Since 1973, we have experiencedthree additional recoveries, during which productivity advances averaged3.

4 percent per year. The reduction in the pace of productivity growthduring recoveries after 1973 was smaller than the slowdown of thelong-term trend. Thus, productivity increased during the pre-1973recovereies at 1.4 times the long-term rate; after 1973, the recoveriesaveraged four times the slower trend which characterized the lastdecade. The manufacturing sector–which is much smaller than the nonfarmbusiness sector–tends to be more volatile. As in the nonfarm businesssector, the trend also slowed; between 1984-73 and 1973-83 the averageannaul rate of productivity growth declined from 2.9 to 1.8 percent.

But in contrast to the more comprehensive nonfarm business sector, thegains in the recovery period have been larger since 1973. In the firstfive recoveries, productivity advances averaged 4.8 percent annually; inthe three most recent rebounds they averaged 5.7 percent and the mostrecent recovery showed gains at a 4.5-percent annual rate. The highest nonfarm productivity growth occurred after the threetroughs when output per hour advanced at a 4.1-percent annual rate. Thesmallest posttrough gain occurred following the 1980 trough.

(See table1.) From the standpoint of productivity advance, the current recoveryis somewhat stronger than the average of similar stages of recovery inthe nonfarm sector and weaker than average in manufacturing. Chart 1compares movements in productivity and related measures in this recoverywith the average of the previous seven recovery periods in the nonfarmand manufacturing sectors. In the six posttrough quarters, nonfarm output has increased at anaverage annual rate of 7.0 percent in the previous cycles, but theadvance after the most recent trough has been faster–9.8 percent. Hourshave also rebounded from the trough level more rapidly than during pastrecoveries. Table 1 shows the annuals rates of change in output, hours, andrelated measures.

Manufacturing output and hours also advanced morerapidly in this recovery, although the rate of productivity gain issmaller than average. Hourly compensation increases during the present recovery have beensmaller than during earlier upturns. This measure, which includes wagesand salaries, supplements, and employer payments to all employee benefitplans, represents the largest cost to most producers. In the sevenprevious recoveries, hourly compensation increased at a 6.4-percentannual rate in the nonfarm business sector, while in the presentrecovery, the increase was 4.2 percent over the six quarters. Moreover,in recent recovery periods, hourly compensation advances have approached10 percent in the six quarters following the trough. (See tables 2 and3.

) Thus, the slower gain in hourly compensation, coupled with theproductivity increase, resulted in a small rise in unit labor costs(compensation per unit of output) for the nonfarm sector. Nonfarm unitlabor costs ros at a 0.2-percent annual rate in the six quarters afterthe trough; in the preceding recovery (after the 1980 trough) thesecosts rose 7.4 percent in just four quarters. In manufacturing, hourly compensation increased at a 3.

0-percentrate over the six quarters of the recovery, compared with an averagerate of gain of 6.2 percent during previous recoveries. This slowerincrease, combined with the advances in labor productivity, resulted ina 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 totalcosts, the more favorable performance of unit labor costs during thecurrent recovery means less upward pressure on prices. This also allowsfor noninflationary growth of profits and nonlabor cost items, which canbe a source of business saving and investment. Quarterly measures of profits and profits per unit of output areonly available since 1958 and only for the nonfinancial corporatesector. The following tabulation shows the average annual rate ofchange (in percent) in profits in the six posttrough quarters for thesector. (Third-quarter 1980 shows the change in just four posttroughquarters.) The very large increase in total corporate profits and in profitsper unit of output partly reflects the downturn in unit labor costsduring the current recovery. Unit labor costs declined 0.2 percent inthe six quarters after the 1982 trough, compared with an increase of 7.

0percent in just four quarters after the July 1980 trough. Thiscontributed to the very different performance of profits in these twocycles. Periods of contraction In response to major cyclical contractions in the demand for goodsand services, output, employment, productivity, and prices all diverge from long-term trends. Little can be inferred about the divergence inproductivity from the length of the recession alone. Two of the earliercontractions (1948-49 and 1969-70) lasted 11 months; in one case,productivity growth slowed to 0.6 percent in the nonfarm sector, and inthe other it grew 1.1 percent.

(See table 4.) Two contractions(1952-53 and 1960-61) lasted 10 months; int he former, productivity wasunchanged, 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, itdeclined 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 recentcase productivity declined 0.

3 percent, in the earlier instance, it fell2.6 percent during the 16-month period. Growth of output per hour ofall persons in nonfarm business either slowed or ceased in the first ivepostwar 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 sinceWorld War II. The most recent contraction began in July 1981 and endedin November 1982, 16 months later. We have seen that only the 1973-75contraction lasted as long; on average, the upturn has come 10 monthsafter the peak of the business cycle.

Nonfarm business output declinedmore during 1981-82 than the average of previous contractions, and thecutbacks in hours and employment were also severe. Hours were reducedin four of the five quarters following the onset of the 1981-82contraction. Nonfarm employment had not been cut as sharply since thelate 1950’s, and manufacturing employment fell a recordamount–10.2 percent. This situation may be partly explained by thefact that there was a relatively short interval between this contractionand the previous one–only 12 months–and employers did not maintainemployment because demand was falling again. In addition, the period ofrapid growth of hourly compensation carried over into the downturn,which made labor “hoarding” increasing expensive.

Bothnonfarm hourly compensation and unit labor costs rose almost twice asmuch during the 1981-82 downturn as during the average contraction.Hourly compensation also advanced rapidly in manufacturing during thecontraction. Unit labor costs (compensation per unit of output) are affected bychanges in productivity (output per hour) and compensation per hour. Ifproductivity and hourly compensation change equally, unit labor costsare unaffected. Chart 2 shows the relationship between these seriessince 1973. Declines in productivity during postwar contractions arethus related to periods of rapid increases in unit labor costs. Contrasting trends were evident in manufacturing. Whileproductivity grew modestly in durables as large increases occurred inboth output and hours, a more rapid productivity gain was experienced innondurable goods manufacturing, where increases in output and hours werenot as robust.

As a result, unit labor costs declined more innondurables. There is also a significant difference between thesecond-quarter productivity advance in nonfarm business (5.5 percent)and that for nonfinancial corporations (2.

8 percent), which account formore than 75 percent of nonfarm business output. Most of thisdifference can be explained by the larger rate of increase of hours inthe nonfinancial corporate sector than in nonfarm business, whichincludes the self-employed and financial activities. The following tabulation shows the percent changes at annual ratesin productivity, output, and hours for the second quarter of 1984: Compensation and labor costs. Compensation per hour of all personsengaged in the nonfarm business sector rose at a 3.

7-percent annual ratein second-quarter 1984, but remained unchnaged after allowing for theincrease in the Consumer Price Index for All Urban Consumers (CPI–U).Unit labor costs declined 1.7 percent in the second quarter, comparedwith a 3.

1-percent annual rate of increase in the first quarer. In manufacturing, hourly compensation increased at a 2.9-percentannual rate in the second quarter (or fell 0.8 percent after allowingfor the increase in the CPI–U), and unit labor costs declined 1.

1percent. Employment and hours. Labor input used in BLS productivitymeasures is hours of paid labor time. Adjustments to labor input inresponse to changes in demand can be accomplished through changes in theworkweek as well as changes in employment. In the nonfarm businesssector, employment maintained the high growth rate of the first quarter,while average weekly hours decelerated in the second quarter. thismarket the sixth consecutive quarter of increasing average weekly hours,the longest period of such growth in the series. Employment growthslowed, and the workweek was shortened somewhat in manufacturing in thesecond quarter.

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