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posted on 05 February 2015

4Q2014 (Preliminary): Productivity Contracts, Costs Up

Written by Steven Hansen

A simple summary of the headlines for this release is that the growth of labor costs is increased significantly from the previous quarter, whilst the rate of growth of productivity actually declined. If one looks at the year-over-year data - it is saying the same thing.

The market was expecting:

seasonally adjusted quarter-over-quarter at annual rate Consensus Range Consensus Preliminary Actual Final Actual
Nonfarm productivity -1.5 % to 1.0 % 0.2 % -1.8 %
Unit labor costs 0.7 % to 2.6 % 1.2 % +2.7%

The headlines annualize quarterly results (Econintersect uses year-over-year change in our analysis). If data is analyzed in year-over-year fashion, business productivity was down 0.3% year-over-year, and unit labor costs were up 2.0% year-over-year. Bottom line: the year-over-year data is saying that costs are rising MUCH faster and productivity declining.

Although one could argue that productivity improvement must be cost effective, it is not true that all cost improvement are productivity improvements. [read more on this statement] Further, the productivity being measured is "capital productivity" - not "labor productivity". [read more on this statement here]

Even though a decrease in productivity to the BLS could be considered an increase in productivity to an industrial engineer, this methodology does track recessions. [The current levels are well above recession territory.

Please note that the following graphs are for a sub-group of the report nonfarm > business. Business sector real productivity is growing slower year-over-year than last quarter (see graph below).

Seasonally Adjusted Year-over-Year Change in Output of Business Sector

And the year-over-year output per person was worse than the last quarter (see graph below).

Seasonally Adjusted Year-over-Year Change of Output per Hour for the Business Sector

All this is happening while business sector unit labor costs increased - but growth is at a slower rate than last quarter.

Seasonally Adjusted Year-over-Year Rate of Change of Unit Labor Costs

The headlines from the press release:

Nonfarm business sector labor productivity decreased at a 1.8 percent annual rate during the fourth quarter of 2014, the U.S. Bureau of Labor Statistics reported today, as output increased 3.2 percent and hours worked increased 5.1 percent. (All quarterly percent changes in this release are seasonally adjusted annual rates.) The increase in hours worked is the largest increase in this series since a gain of 5.7 percent in the fourth quarter of 1998. From the fourth quarter of 2013 to the fourth quarter of 2014, productivity was unchanged as output and hours worked both increased 3.1 percent. (See chart 1 and table A.) Annual average productivity increased 0.8 percent from 2013 to 2014.

Labor productivity, or output per hour, is calculated by dividing an index of real output by an index of hours worked of all persons, including employees, proprietors, and unpaid family workers.

Unit labor costs in the nonfarm business sector increased 2.7 percent in the fourth quarter of 2014, reflecting a 0.9 percent increase in hourly compensation and a 1.8 percent decline in productivity. Unit labor costs increased 1.9 percent over the last four quarters.

BLS calculates unit labor costs as the ratio of hourly compensation to labor productivity; increases in hourly compensation tend to increase unit labor costs and increases in output per hour tend to reduce them.

Manufacturing sector productivity increased 1.3 percent in the fourth quarter of 2014, as output increased 5.7 percent and hours worked increased 4.3 percent. Productivity increased 1.5 percent in the durable manufacturing sector and increased 0.2 percent in the nondurable manufacturing sector. (See tables A, 3, 4, and 5.) Over the last four quarters, manufacturing productivity increased 2.8 percent, as output increased 4.8 percent and hours increased 1.9 percent. Unit labor costs in manufacturing increased 0.2 percent in the fourth quarter of 2014 and decreased 0.4 percent from the same quarter a year ago.

preliminary chart:

final chart:

Caveats Relating to Productivity

Productivity is determined using monetary criteria, and does not recognize outsourced man hours - in other words, if a business cuts half of its workforce by outsourcing a sub-component or sub-service, this would be a 50% productivity improvement.

These productivity measures describe the relationship between real output and the labor time involved in its production. They show the changes from period to period in the amount of goods and services produced per hour. Although these measures relate output to hours at work of all persons engaged in a sector, they do not measure the specific contribution of labor, capital, or any other factor of production. Rather, they reflect the joint effects of many influences, including changes in technology; capital investment; level of output; utilization of capacity, energy, and materials; the organization of production; managerial skill; and the characteristics and effort of the work force.

Econintersect believes a better measure (if you must use monetary tools to tract productivity) would be competitiveness.

Looking at productivity / output long term - output fall below 0% year-over-year change is a good sign that a recession is underway. Another way to look at it - if productivity rate of gain is falling, this could be an indicator a recession is coming.

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