Gauging productivity

The Bureau of Labor Statistics (BLS) issued its preliminary report for second-quarter productivity. The most noteworthy data in the BLS report were the large revisions for 2004, 2005 and 2006.

The average annual compounded growth rate of productivity (output per hour of labor) in the nonfarm business sector from the end of 2003 to the end of 2006 was revised downward from 1.9 percent to 1.4 percent. The growth rate during 2006 (fourth-quarter over fourth-quarter) was reduced from 1.6 percent to 0.8 percent. Unit labor costs during the latest four quarters increased by 4.5 percent, the largest four-quarter increase in nearly seven years. It was further evidence contributing to the Federal Reserve's recent statement that "a sustained moderation in inflation pressures has yet to be convincingly demonstrated" — a major reason the Fed decided against lowering short-term interest rates.

After reaching a cyclical peak of 4.1 percent in 2002, the annual growth rate of productivity has now declined four years in a row, falling to 1 percent in 2006, its lowest annual growth rate in more than a decade. Economists now worry that the dramatic acceleration of productivity, which began in 1996 and continued through 2005, may be petering out. Such an adverse development would exert negative effects throughout the U.S. economy over the long term.

The growth rate of productivity determines the potential for living standards to rise, although the fruits of rising productivity are not distributed equally. Between 1947 and 1973, productivity increased at an average annual rate of 2.8 percent. Over the next 22 years (1974-95), the average annual growth rate fell to 1.4 percent. During the next decade (1996-2005), productivity increases once again averaged 2.8 percent per year, before falling to 1 percent in 2006. The difference between 2.8 percent and 1.4 percent is huge: With the labor hours held constant, the total amount of goods and services produced by an economy can double in 25 years when productivity increases 2.8 percent a year; it would take 50 years to double the amount of goods and services produced in an economy when productivity increases by only 1.4 percent per year.

These large downward revisions in productivity growth rates during the 2004-2006 period were made necessary after the Commerce Department downwardly revised the average annual growth rate of gross domestic product during the same period from 3.2 percent to 2.9 percent. The average inflation-adjusted hourly wage for nonsupervisory and production workers, who make up 80 percent of the private-sector work force, has increased less then 3 percent; and it was lower in June than it was four years earlier.