Earlier this month the Bureau of Labor Statistics (BLS) announced that productivity had grown at an annual rate of 0.9 percent during the second quarter. An increase in productivity might sound good on the surface, but this report actually carried some sobering warning signs. The second quarter's 0.9 percent annual rate of productivity growth is a fall-off from 2012's rate of 1.5 percent, and from the average of 2.1 percent over the last four calendar years. What's even more disturbing is that in the latest BLS report, the estimated rate of productivity growth during the first quarter of this year was revised downward from a positive 0.5 percent to a negative 1.7 percent. This was the result of downward revisions in the original estimates of both output and hours worked, with the drop in the estimate of output being the greater of the two. The result is that output actually declined in the first quarter, suggesting that the economy is slowing and getting less efficient as a result.
The significance of productivityProductivity is a measure of the economy's efficiency. It captures the amount of output a workforce creates per hour worked, so any time output grows faster than the amount of time worked, it means the economy is becoming more efficient. The real significance of productivity is that it has implications for both economic growth and inflation. Productivity tends to grow when economic growth is accelerating. When demand increases, businesses are pushed to operate at closer to full capacity, and growth in output usually happens faster than increases to the workforce. These things result in strong productivity gains. On the other hand, when productivity gains slow, it can be a sign that underlying demand has slowed unexpectedly, signaling trouble for economic growth. Looking back, a sudden drop in productivity in 2006 might have been a warning sign of the coming recession. Productivity gains averaged a very healthy 3.1 percent in the 10 years through 2005, but then dropped to 0.7 percent in 2006.
Productivity also has an influence on inflation trends. If output is rising faster than the hours worked, it indicates that efficiency is growing and this efficiency helps moderate price increases. Productivity growth can be a key to achieving strong economic growth without high inflation.