Productivity Rises 2.6% in 4Q - Analyst Blog

Non-Farm Business Productivity grew at 2.6% (seasonally adjusted annual rate) in the fourth quarter, an acceleration from the 2.4% rate in the third quarter. The third quarter numbers were revised up slightly from 2.3%. For 2010 as a whole, productivity rose by 3.6%, up from 3.5% for all of 2009, and just 1.0% in 2008.

Productivity is the output per hour, and thus depends on two things: output, which roughly corresponds to GDP growth, and hours, which roughly corresponds to employment (and the average workweek). The growth in output does not exactly match GDP growth, however, as inventories and net exports play a bigger role in the GDP numbers.

In the fourth quarter, output surged by 4.5%, up from 3.8% in the third quarter and 1.6% in the second quarter. Hours worked also picked up, rising 1.8%, up from 1.4% growth in the third quarter but down from 3.5% in the second quarter.

For all of 2010, output increased by 3.7%, up sharply from a decline of 3.8% for all of 2009 and a 1.1% decline for all of 2008. Hours worked edged up only slightly for all of 2010, rising 0.1%, but that was sure better than the collapse of 7.0% in 2009 on the heels of a 2.1% decline in 2008. As I discuss below, over the long term growth in productivity is vital, as it holds the key to increasing standards of living, but in the short term it can be a mixed blessing at times of high unemployment.

Manufacturing Productivity

Manufacturing productivity actually accelerated to 5.8% growth from 1.4% growth in the third quarter, and was even better than the 5.7% rise in the second quarter. However, when one looks a bit deeper, the number looks a bit weaker than we would like to see.

The growth in manufacturing output actually slowed to 3.7% from 5.0% in the third quarter and a stunning 9.9% in the second quarter. Hours worked in manufacturing actually feel at a 2.0% rate in the fourth quarter, down from growth of 3.6% in the third quarter and 4.0% growth in the second quarter.

For 2010 as a whole, manufacturing output climbed 6.6%. That is a great showing, but it does not come close to reversing the 10.8% decline for all of 2009 which came on top of a 4.0% decline for all of 2008. Hours worked edged up 0.6% for all of 2010, which barely started to touch the massive 12.6% fall in 2009 and the 4.0% decline in 2008.

Durable Goods

The increase in productivity has been particularly impressive in the durable goods side of manufacturing. Companies like Ford (F) and Whirlpool (WHR) were able to increase output in the second quarter by 4.1% but were able to do so while they slashed hours worked by 1.7%. That resulted in a 6.0% increase in productivity.

In the third quarter, durable goods were a major laggard, with productivity rising just 0.1%, even though output surged by 6.7%, hours worked increased by 6.6%. The second quarter was the really impressive one, when durable goods manufacturing productivity surged by 11.9% on a 15.4% increase in output and a 3.1% increase in hours worked.

Looking at the full year, 2010 was an outstanding year for durable goods productivity growth, with a rise of 8.2%, up from a decline of 0.2% for all of 2009, and a decline of 1.6% in 2008. Output growth accelerated to 8.8% for all of 2010, from a collapse of 15.3% in 2009, on top of a decline of 5.7% in 2008.

Just think of the Auto industry as the prototypical durable goods manufacturing industry. In 2009, General Motors (GM) and Chrysler both had to file for bankruptcy, and Ford was on the ropes. Now both Ford and GM are back to making massive profits.

In 2009, the hours worked collapsed by 15.1%, on top of a 4.2% decline in 2008. In 2010, durable goods manufacturing hours worked edged up by 0.6%.

Non-Durable Goods

The non-durable goods manufacturing side, which is about twice the size of the durable goods side as a share of the economy and employment, tends to be a bit more stable. Firms like Altria (MO) and Heinz (HNZ) were able to increase output in the fourth quarter by 3.2%, which was just a bit faster than the 3.1% rise in the third quarter and down from the 4.0% growth pace of the second quarter. They were able to do so as they cut hours worked by 2.4%, on top of a 1.0% decline in the second quarter. In the second quarter, though, non-durable manufacturing hours worked rose by 5.3%.

As a result non-durable manufacturing productivity growth rose at an annual pace of 5.8% in the fourth quarter, up from 4.2% growth in the third quarter and a decline of 1.3% in the second quarter. For the full year, output was up 4.1% in 2010, but that only partially reversed the 5.5% decline in all of 2009 and the 3.3% decline in 2008 as a whole.

Hours worked edged up by 0.6% in 2010, but that came on the heels of a 8.3% decline in 2009 and a 3.7% decline in 2008. Productivity for the full year accelerated to 3.5% from 3.0% in 2009 and just 0.4% in 2008.

Productivity Growth Vital Over Long-Term

Over the long term, productivity growth is probably the single most important economic statistic there is. It is productivity growth that governs the rise in GDP per capita. GDP per capita is the best shorthand measure around for determining how wealthy a country is.

(Yes, I know that there are serious flaws with GDP as the be-all and end-all of economic happiness -- Bobby Kennedy made the point rather eloquently back in 1968 and his points are still valid -- but for a single number it does a pretty good job. After all, the GDP of China under Mao was significantly larger than the GDP of Sweden at the time, but nobody -- other than perhaps some extremely delusional Marxists -- thought that the Chinese were better off economically than were the Swedes.)

In the short term, particularly as the country suffers from high levels of unemployment, the matter is not nearly that simple. You can have a rise in productivity if output is falling, but businesses are laying off people faster than they are cutting output, and that clearly does not lead to higher GDP per capita or a wealthier society.

Rising productivity can also lead to large disparities in incomes, particularly if it is being caused by an increase in unemployment due to fewer hours worked. The tie between a rise in productivity and a rise in national wealth is conditional upon reasonably full employment.

With unemployment at 9.4% (in December, we will see tomorrow where it was in January) and there only by grace of a falling participation rate (people dropping out of the workforce altogether so they are neither employed nor unemployed), a rise in productivity is not necessarily such a great thing. We need to put people back to work, even if the rise in hours worked is not quite matched by a gain in output.

The Investor's Eye View

From the point of view of an investor, rather than that of a citizen who is interested in the overall health of the economy, the rise in productivity is good news, regardless if it comes from higher output or lower hours worked. Gains in output are going to roughly correspond with increases in revenue, increases in hours worked generally means increases in costs.

Since for most firms wages are one of the biggest expense line items, having to hire more people (or have existing workers work more hours) without generating a corresponding increase in output is going to put downward pressure on margins.

We have seen a remarkable rise in margins over the last year. For the S&P 500, net margins in 2010 are expected to be 8.67%, up from 6.42% in 2009. Granted, much of that increase is coming from the financials, where the increase in net income is more about lower write-offs and provisions for bad loans than it is from increasing labor productivity.

However, even excluding the financials net margins are expected to rise to 8.23% from 7.13%. For 2011, the forecasts are for total net margins to continue to climb to 9.50% and excluding financials for net margins to rise to 8.83%.

Unit Labor Costs

A big part of the increase in net margins is that unit labor costs are extremely well controlled. Unit labor costs are how much it costs the employer in wages and benefits to produce an item. For non-farm business as a whole, unit labor costs fell 0.6% in the fourth quarter, on top of a 0.1% decline in the third quarter.

The second quarter was a bit of an anomaly as unit labor costs rose 4.9%. However, for 2010 as a whole, unit labor costs were down 1.5% on top of a 1.6% decline in 2009. In 2008, unit labor costs rose 2.2%.

The decline in unit labor costs was more pronounced in manufacturing than in the rest of the economy, plunging 2.9% in the fourth quarter, after having edged up 0.1% in the third quarter but after a 0.8% decline in the second quarter (and a massive 8.1% plunge in the first quarter).  For the full year manufacturing unit labor costs fell 4.5% in 2010, after falling 3.5% in 2009 but after rising 4.3% in 2008.

Back in the ancient past, productivity growth was roughly evenly shared between the owners of capital and the providers of labor. The sharing of productivity growth seems to be fair -- better tools and processes, which are made possible by capital -- are essential for productivity to rise.

The old saying was, "The difference between a Chinese coolie and an American truck driver is the truck." Given the changes in China over the last few decades, I'm not really sure that holds anymore in the specifics. The general point about the truck driver being able to haul more goods faster than someone carrying the stuff by hand still holds. The key difference is the truck, i.e. the capital being used.

On the other hand, if someone is producing 5 widgets per hour, when he used to only make 4 per hour, it seems fair that he should get paid more. That sharing no longer takes place in the U.S. economy -- that is what the decline in unit labor costs is telling us. All the gains are accruing to capital, in the form of higher net margins and hence higher profits. The worker is reaping almost none of the gains.

On a quarter-to-quarter basis there is a strong inverse relationship between productivity growth and unit labor costs, and that has always been the case. However, the two graphs below show the behavior of both productivity over the course of 25 years (year over year % change). The first one is over the last 25 years, and the second one is between 1960 and 1985.

Notice that in the more recent period, particularly over the last decade, how much higher productivity (blue line) has tended to run than unit labor costs (red line). In the earlier period, unit labor cost growth tended to be much higher than productivity growth. The change in behavior of both series around recessions is remarkably different between the two periods.

Back in the ancient past, productivity would plunge, and unit labor costs would soar during a recession. Recently the exact opposite has been happening.





Growing Disparity

The net result is an ever increasing disparity of incomes in the society. Incomes in the U.S. are as unequal as they were back in 1929. I don't think the economic collapse that followed and the economic collapse that followed reaching the same sorts of levels of inequality in 2008 are unrelated. The U.S, has by far the most unequal distribution of income in the developed world, and indeed, a much higher level of inequality than many developing countries.

The best single measure of inequality is known as the Gini index, which ranges from a reading of 0.00, where each and every person has exactly the same income, to 1.00 where a single person or family has all of the income. Obviously no society has ever hit either of those extremes, and each would be a horror story if they did. Cambodia under the Khmer Rouge was probably the closest the world has recently seen to a Gini index of 0.00. Czarist Russia came relatively close to a Gini index of 1.00.

The international comparison numbers are not all from the same year, so there is a bit of an apples-to-oranges flavor to the numbers. Still, many have pointed to the extreme inequality in Egypt as one of the root causes of the current unrest there. However, based on CIA data, in 2001 Egypt had a Gini index of 0.344. In 2007, the U.S. Gini index was 0.450.

The European Union as a whole had a Gini index of 0.31 in 2006. The range of Gini coefficients runs from a low of 0.23 for Sweden (2005) to Nabibia at 0.707. If you only want to look at fairly large economies, the highest is South Africa at 0.65 (2005). (Data available here.)
 
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