Declining Productivity and Why it Matters

By SBE Council at 6 March, 2015, 11:47 am

Productivity Worries Persist

Productivity has been abysmal for the past four years – in fact, for a decade, now. That’s trouble on various fronts, including incomes.

The latest data from the U.S. Bureau of Labor Statistics saw fourth quarter 2014 nonfarm business sector labor productivity revised down from a poor -1.8% to an even worse -2.2%.

As explained by the BLS, “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.”

Why does productivity matter?

Income is tied strongly to productivity. Private-sector investment boosts labor productivity, and feeds into economic growth and income growth. Indeed, the link between productivity and earnings cannot be ignored, as more productive workers – with their productivity enhanced via investments in technology, physical capital, and education, for example – can demand higher compensation. To link it back to one’s own career, the more valuable, that is, productive, you make yourself in the marketplace, the greater your market compensation.

We’ve heard a good deal about lagging salary and wages recently. There are various aspects to this story, including poor economic and employment growth for more than seven years, and poor productivity growth.

Consider that for all of 2014, productivity growth registered only 0.7%. That followed on 0.9% for 2013, 1.0% for 2012, and 0.2% in 2011. The average for the past four years was a woeful 0.7%. These recent numbers compare, for example, to a post-World War II average of 2.2%, 1.9% since 1970, and 2.1% since 1990.

In fact, after solid productivity growth from 1996 to 2005 (average productivity gains of 3.0%), productivity growth has averaged only 1.4% since. The only years from 2006 to 2014 that experienced strong productivity growth were 2009 and 2010, which have to be taken with a grain of salt due to a recession reducing employment and businesses working to gain efficiencies at the same time.

So, when we talk about the lack of wage growth, three factors need to be kept in mind:

• We’ve had poor productivity growth for a near-decade now, especially over the past four years.

• Poor economic and employment growth obviously have restrained wage growth in general.

• Poor economic, employment, productivity, and income growth can all be tracked back to sluggish private investment growth and a decline in entrepreneurship. These points have been noted in recent analysis – for example, an SBE Council Cybercolumn on investment and an SBE Council Fact of the Week on self-employment trends.

For politicians complaining about the lack of wage growth, the answer certainly is not to impose additional mandates on small businesses – such as jacking up the minimum wage – which obviously discourages hiring and reduces other compensation, but instead to reduce government burdens, such as taxes and regulations, on private-sector risk taking, that is, on entrepreneurship and investing.

Raymond J. Keating, Chief Economist