Recession and the Productivity Plunge

By SBE Council at 9 August, 2022, 3:04 pm

by Raymond J. Keating – 

Productivity often is treated like an economic mystery. But there’s no real mystery about productivity.

Nonfarm business sector labor productivity, or output per hour, is determined “by dividing an index of real output by an index of hours worked by all persons, including employees, proprietors, and unpaid family workers.”

Productivity is boosted via investment in, for example, innovations, tools, equipment, technology and education. Entrepreneurs, and the investors who fund them, help to fuel productivity by creating new and better ways of doing things, and/or creating new goods, services and industries. In turn, both workers and employers benefit from enhanced productivity via increased wages, salaries and profits.

So, when we look at the data on productivity, we obviously want to see growth. Specifically, the ideal scenario is growth in both output and hours worked, with the growth in output obviously running ahead of the growth in hours worked.

Unfortunately, the latest productivity data are troubling, and reflect our current stagflation environment.

The Productivity Plunge

Productivity plunged by 4.6 percent (compared to the previous quarter at a seasonally adjusted annual rate) in the second quarter, with output declining by 2.1 percent and hours worked increasing by 2.6 percent. That comes after a productivity decline in the first quarter of 7.4 percent, with output falling by 2.5 percent and hours worked increasing by 5.3 percent.

Compared to a year earlier, second quarter productivity was down by 2.5 percent, with output growth at 1.5 percent and hours worked up by 4.1 percent. As noted in the report, “The 2.5-percent decline in labor productivity from the same quarter a year ago is the largest decline in this series, which begins in the first quarter of 1948.”

Source: Federal Reserve Bank of St. Louis, FRED

As noted in the above chart, there were some wild swings in productivity tied to the pandemic. Given those outliers, the productivity data for 2020 and much of 2021 have to be taken with a big grain of salt. Still, as we move further away from the initial shocks of the pandemic, we get back to a more realistic view on productivity. And these last two quarters of decline certainly line up with the recession.

However, there’s nothing inevitable about the recession and decline in productivity. Indeed, given where the economy is relative to its pre-pandemic levels, one might expect growth in the economy and productivity to be strong as we work back to where we should be. But part of the problem is anti-growth policymaking pushing higher taxes (see the so-called “Inflation Reduction Act,” for example), increased regulation, protectionism on trade, and more government spending. That’s a recipe for less investment and entrepreneurship, and therefore, lost economic and productivity growth.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council. His latest book is The Weekly Economist: 52 Quick Reads to Help You Think Like an Economist.