Productivity Increased 2.3% – And This May Be Bad News

According to the Bureau of Labor Statistics (BLS),  labor productivity increased in 3Q2010 at an annual rate of 2.3%.  The headline:

Nonfarm business sector labor productivity increased at a 2.3 percent annual rate during the third quarter of 2010, the U.S. Bureau of Labor Statistics reported today. Labor productivity is calculated by dividing an index of real output by an index of the combined hours worked of all persons, including employees, proprietors, and unpaid family workers.

Productivity to Industrial Engineers is defined as a metric which measures technical or engineering efficiency of production.  Productivity in simple terms is the number of tasks completed (units manufactured) by the number of manhours worked.  The comparison of productivity over time is how efficiency is measured.  If more widgets are made by the same number of people – productivity has increased.

This improvement can be attributed to many factors including automation, improved design, better worker training, or a whole slew of other factors.

The Bean Counter Approach

Do not confuse the above discussion with the “bean counter” productivity used by the BLS in this report.  Because, in addition to the factors allowed to be included in productivity analysis – bean counters allow the introduction of disconnects in vertical integration to be counted in productivity.  In layman’s terms, bean counters allow outsourcing to be counted as a productivity improvement.

Bean counters focus on money flows.  Bean counter productivity is geared to measure costs.  The easiest example to understand this point is automobile production.  If making the car engine requires 22% of the manhours it takes to fabricate and assemble the entire car – and you outsource the engine to another company – a bean counter within the car company would claim 22% productivity improvement.

This is not productivity improvement – and it may not even be cost improvement.

How productivity is measured goes to the very core of a country’s economic foundations.  A country which does not continuously improve productivity will be faced with loss of domestic production to lower cost producers and/or rising prices.  If outsourcing is included in productivity calculations, it puts a wobble into this calculation – especially if the outsourcing is going overseas.

The BLS productivity numbers are meaningless if outsourcing cannot be removed from their calculation.  If any of the increased productivity has come from lower cost per unit of domestic production it may or may not be good.  If it comes from outsourcing overseas it is likely not a net positive for the country in many cases.  Let me amplify both points.

Increased Productivity, Reduced Demand

If the lower cost per unit for domestic production comes from increased output per employee it is good from two points of view; the cost of the product is lowered for the consumer and the potential for increased profit margin accrues within the country.

The negative aspect of real productivity improvement is that increased productivity reduces labor content and labor earnings.  Reduced labor earnings reduces the potential for domestic consumption.  Reduced consumption leads to reduced demand and production declines unless the reduced domestic demand is offset by increased exports.  As production declines, an economy of scale tipping point can be violated thus losing the productivity gain.  The downward spiral of demand has greater potential to be realized when the productivity gain results from outsourced production across national borders.  In that case, not only is labor cost reduced, but domestic demand is lowered further by whatever labor cost is transferred overseas.  This increased productivity / reduced demand phenomenon is part of the economic headwinds of the new normal.  The solutions are not apparent when you remain focused on money flows.