Large Drop in Productivity Could Weigh on Corporate America's Growth Ambitions

The Bureau of Labor Statistics (BLS) has released its reading on labor productivity and unit labor costs for the fourth quarter. If you were a bit surprised that the fourth quarter gross domestic product was not really that close to 3%, the productivity report may have been at least some influence on the report. If these trends continue, some of corporate America’s expansion and growth ambitions could be tempered.

According to the preliminary report from the BLS, nonfarm productivity per hour fell by 0.1% in the fourth quarter. One of the driving forces was that hourly wages were up 1.8% and all combined unit labor costs (including benefits and related costs) was up 2.0% in the quarter. As a reminder, if wages and labor costs rise more than total output, and all other things are equal, then productivity tends be viewed as weak.

While this was the first productivity decline since the first half of 2016, the consensus estimates were looking for larger gains. Thomson Reuters had a consensus estimate of 1.0% growth in fourth-quarter productivity, and Dow Jones had its published consensus at a less aggressive gain of 0.6%. And to make matters worse, the third-quarter productivity number was revised to a gain of 2.7% from a preliminary gain of 3.0%.

For all of 2017, the weak report and the lower revision took the annualized productivity to a growth of just 1.2% over 2016. This is well below a 2% floor that most businesses expect to see each year, and it makes it harder for employers to want to raise pay and to make large investments.

What is interesting here is that the weakness in the fourth quarter was prior to the impact of tax reform. It was also right before many large companies reported higher wages and bonuses.

If the United States was larger in manufacturing, this report would have looked great. The BLS showed how strong the manufacturing numbers were:

Manufacturing sector labor productivity increased 5.7 percent in the fourth quarter of 2017, as output increased 7.3 percent and hours worked rose 1.5 percent. These were the largest quarterly increases in manufacturing sector productivity and output since the second quarter of 2010, when output per hour increased 7.0 percent and output jumped 10.7 percent. Productivity increased 6.7 percent in the durable goods manufacturing sector and 4.5 percent in the nondurable goods sector in the fourth quarter of 2017. Over the last four quarters, total manufacturing sector productivity increased 1.1 percent, as output increased 2.7 percent and hours worked increased 1.6 percent. Unit labor costs in manufacturing decreased 3.7 percent in the fourth quarter of 2017 and increased 1.1 percent from the same quarter a year ago.

Stocks were initially weak into the opening bell after the weaker productivity numbers. That said, the Dow Jones Industrial Average was down just five points, and the S&P 500 was down only one point on last look. The major indexes remain within about 2% of all-time highs. The yield on the 10-year Treasury was last seen up one basis point at 2.73%, in a range so far this week of just 2.69% to 2.75%.

At the end of the day, it is important to keep in mind that productivity gains actually compete with rising wages and labor costs. If total output from companies rises more than wages, then productivity is counted as being higher. If wages and labor costs increase more than total output, then productivity drifts lower. Now we just have to see what the impact will be from all the wage hikes and bonuses announced after corporate tax reform. This could create a more volatile theme around productivity and unit labor costs for much or all of 2018 and even into 2019.

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