Rising Productivity

I don’t expect reporters to have much in the way of business literacy. Strategic planning and discounted cashflow analysis are difficult subjects, and it doesn’t surprise me that they aren’t part of the normal journalism curricula. But algebra? I had algebra in the 8th grade.

The source of my ire is a report that has been put out by the Labor Department, and the interpretation thereof by the media.

The gist of the report is that productivity grew at an unusually rapid rate in the fourth quarter last year. Labor productivity grew at an annual rate of 6.9% during the last three months of the year. At the same time, the report stated that unit labor costs dropped t a rate of 5.9%.

The commentary I have seen on this report so far makes it out to be bad news. The viewpoint seems to be that rising productivity means income is dropping. Also, if employers can increase output without hiring more workers, that doesn’t help the unemployed. This ignores the reality that increasing productivity is what increases standards of living. Without increasing productivity, we’d all be stuck at the hunter-gatherer stage, which doesn’t strike me as too much fun at all.

But what really gets me is the assumption that when labor costs fall, that means households have less money to spend. This is a complete misreading of the statistics.

What the report actually says is that unit labor costs have fallen. That does not mean workers are getting paid less. It means that workers are producing more product for the same amount of money. In point of fact, falling unit labor costs are just the same thing as rising productivity, expressed in a different way.

Let’s take an example. Assume that in 2008, a worker getting paid $10 per hour produces 100 units of product in an hour. The unit labor cost of that product is $.10, the $10 the worker got paid divided by the 100 units produced.

In the fourth quarter of 2009, the same worker would have produced 107 units of product in the same hour of production. To figure out the increase in productivity, we divide the 4th Q 2009 output by the 2008 output to get 1.07. Productivity increased by 7%. In this same example, the unit labor cost drops to $.0935. This is a 6.5% drop in unit labor costs. But the worker still gets the same $10 income he got before.

The real news is that productivity growth of over 6% cannot be sustained. That red hot pace is an artifact of starting from a lower base level, due to the recession induced drop in demand. Once demand started to pick up, the workforce that businesses kept on in anticipation of an upturn went from coasting along to serious work. A big jump in production was the result. It probably doesn’t hurt that most businesses, given any kind of a choice, will keep their most productive workers on the payroll, dropping the less than stellar performers.

This sharp jump in productivity is a sign that demand is picking up again. Once businesses have wrung all the benefit out of the existing workforce that they can get, the next step is to start hiring more employees.

Increasing productivity is good news, not bad news.