Is Anyone Else Concerned About U.S. Productivity?

Taking issue with productivity during the dog days of summer may seem somewhat hypocritical, but a recent visit to a local amusement park started the wheels turning about a subject that has seemingly fallen out of the spotlight: U.S. labor productivity. Historically viewed as a key component in the determination of growth for wages, prices, and economic activity, it seems that labor productivity has lost the attention of many market pundits, although this is not likely to continue for much longer.

But first, here’s an illustration. Back-dropped against one of the hottest days of the year, this annual pilgrimage was characterized by an afternoon of inordinately long lines and masses of aggravated, clammy patrons waiting in anticipation for a brief interlude of exhilaration. While excess ride demand is typically the culprit for longer-than-normal wait times, in this case, it was supply. Specifically, three of the amusement park’s major attractions were completely shuttered, one of the park’s most popular rides was experiencing persistent “technical difficulties,” and a number of attractions were running with “reduced capacity.”

However, in the purest flash of irony, the park’s newest technological improvements provided patrons riding a traditional roller coaster with a virtual reality (VR) headset, integrating a three-dimensional visual experience of an F-14 fighter jet simulator coordinated to the physical thrill of the coaster’s loops and drops. Sounds pretty cool, right?

And, apparently it was fantastic – if you were one of the lucky few that actually received a functional headset. Those not as fortunate were treated to a static photo or complete darkness for the duration of the ride. Rather than improving efficiencies, this assimilation of advanced technology actually ground the loading process to a “virtual” standstill, as a half dozen college-aged employees worked feverishly to clean and repair an insufficient supply of VR headsets.

Despite the obvious frustrations of the afternoon, the idle waiting did provide time to ponder, of all things, economics. The connection between the amusement park’s productivity issues was a stark illustration of the labor productivity issues facing the broader U.S. economy. In particular, how a shortage of investment spending can impact an organization’s levels of operations and productivity, client satisfaction, and eventually, the firm’s profitability.

Labor Productivity In The United States
An even more interesting realization during these periods of reflection was that despite the importance of productivity in personal income, corporate profits, and economic growth, the subject of labor productivity has not really received a great deal of press recently. In reviewing the Fed’s most recent minutes from the June 2016 Federal Open Market Committee (FOMC) meeting, U.S. labor productivity received one fleeting comment, reflecting that: “Labor productivity growth remained slow over the four quarters ending in the first quarter of 2016.”1

Yet, the U.S. Department of Labor’s most recent release of U.S. hourly output per worker sounded a more ominous tone than the Fed, with the second quarter of 2016 real output per hour declining 0.5%. This marked the third consecutive quarter of annualized contraction, and represented the longest stretch of consecutive quarterly labor productivity contraction since 1979.2 (Figure #1)

Fig. #1
Nonfarm Business Sector Real Output Per Hour (Quarterly)
01/1978 – 04/2016

Source: U.S. Bureau of Labor Statistics, Nonfarm Business Sector: Real Output Per Hour of All Persons [PRS85006092], retrieved from FRED, Federal Reserve Bank of St. Louis;, August 15, 2016.

Rising labor productivity may be considered the lifeblood of promoting economic expansion and increasing standards of living within a given economy. A drop in labor productivity indicates that employees are producing fewer finished goods with the same level of unit activity. Less products to sell places pressure on manufacturing firms to raise prices to help compensate for reduced sales volume, or conversely, reduce the number of labor hours allocated towards production. Similarly, manufacturers may decrease capital spending and maintenance in order to protect margins and earning growth, further influencing overall economic growth prospects.

Recent corporate earnings reports for companies within the S&P 500 seem to corroborate the negative trends in labor productivity. Reported corporate profits for firms in the S&P are expected to decline 2.5% during for second quarter of 2016, marking the fifth consecutive quarter of earnings contraction for these companies.3 Similarly, capital investment activity appears to show a reluctance of corporations to apportion capital for facility or equipment improvements, as evidenced by the negative trend in real gross private domestic investment since October 2015, representing roughly 15% of U.S. gross domestic production (GDP). (Figure #2)

Fig. #2
Real Gross Private Domestic Investment
04/2006 – 04/2016

Source: U.S. Bureau of Economic Analysis, Real Gross Private Domestic Investment [A006RL1Q225SBEA], retrieved from FRED, Federal Reserve Bank of St. Louis; August 14, 2016.

It should come as little surprise that within this environment, U.S. economic growth would be stagnant, at best. U.S. GDP during the second quarter of 2016 increased at an annualized pace of 1.2%, a modest improvement from the downwardly revised 0.8% increase in GDP during the first quarter of 2016.4 One of the primary drags during the quarter was the aforementioned decline in domestic investments, as companies reduced spending on structures, equipment, and inventories during the period. If not for a strong 4.2% rebound in consumer spending5, second quarter GDP could very well have been flat, or even negative.

Despite the Fed’s seemingly narrow focus on employment cost indices, inflation, and reported unemployment rates, the recent performance in labor productivity will likely become an area of focus for the Fed during upcoming FOMC meetings when determining interest rate policies. As shown, declining rates of labor productivity can have a material impact on reducing incomes, increasing finished goods prices, higher inflation, lower corporate profitability, and reduced economic production. The real question, however, is what can be done to improve labor productivity?

Possible Reasons For Declines In Labor Productivity
Not unexpectedly, economic theories behind the decline in U.S. productivity are mixed and, in defense of the Federal Reserve, most resolutions are likely above the institution’s pay grade. Some theorize that longer-term trends in constrained capital infrastructure investment may be a large contributing factor towards lower productivity levels, as aging equipment and facilities would naturally constrain a laborer’s ability to efficiently produce goods.6

Another suggested theory proposes that the current labor productivity measurement no longer accurately reflects true U.S. productivity levels, given the U.S. economy’s transition towards a service-driven market model.7 While this theory may hold some legitimacy, the declines in productivity among most developed economies outside the United States, including Japan, Germany, France, and the United Kingdom, would seem to indicate that pressures on labor productivity rates are more of a global systemic phenomenon.

One of the more commonly accepted explanations for the observed declines in global productivity rates has to do with declining marginal returns in efficiencies gained from technological advances. The benefits experienced during the technology boom of the late 1990s provided nearly two decades of labor productivity enhancements, helping to sustain wage growth, corporate profitability, and economic growth during this period. In order to turn the productivity tide, proponents of this concept support greater investments in innovative technologies, infrastructure, and capital investments.8

Admittedly, addressing the slowdown in U.S. productivity is an economic challenge outside of the Fed’s current tool kit, although the recent productivity data point will likely raise pressure on the FOMC to keep interest rates lower for longer. However, it is very likely that the issue of labor productivity will become a highly contested issue during the impending presidential race, now that the August data point will raise the profile of this highly important economic variable.

Until the next Daily Pfennig® edition…

Chuck Butler
Managing Director
EverBank Global Markets Group