Labor Productivity Edges Higher While Costs Fall

source: http://www.flickr.com/photos/imosaad/

source: http://www.flickr.com/photos/imosaad/

Non-farm business sector labor activity increased at a seasonally-adjusted annual rate of 1.9 percent in the third quarter, according to preliminary estimates from the U.S. Bureau of Labor Statistics released on Thursday. This is the function of a 3.7 percent increase in output and a 1.7 percent increase in hours worked on a quarter-over-quarter basis. On the year, labor productivity was flat, with a 1.8 percent increase in output matched by a 1.8 percent increase in hours worked.

Output and hours worked have historically been subject to cyclical mood swings. The third-quarter data follows a second-quarter productivity increase of just 0.9 percent and a first-quarter decline of 1.7 percent. This, in turn, followed an average productivity gain of 1.5 percent in 2012, when output increased 3.7 percent and hours worked increased 2.2 percent. Labor productivity is a highly watched but sometimes nebulous economic indicator. While labor conditions are sensitive to short-term cyclical trends, productivity gains are essential for long-term economic growth. Increases in productivity contribute to real value creation in the economy and can lead to higher wages and economic growth without contributing to inflation.

Broadly speaking, the BLS productivity report tries to establish a measurement of output per unit of labor. There is some fundamental fuzziness in this calculation; output is a function of gross domestic product, input is a function of hours worked, and the costs are a function of all employee compensation including wages and benefits.

Investors can use this data to get a better understanding of the economic backdrop against, which they are making investment decisions. While none of the data are new — the BLS makes calculations off of previously released GDP and labor market data — the report offers a perspective on how effective businesses have been at producing value.

The costs associated with production can be used as a leading indicator of inflationary pressure. Increased labor costs can ultimately be passed on to the consumer, as reflected in the consumer price index or the personal consumption expenditures index, and they affect the headline inflation rate. Conversely, a contraction in unit labor costs — which were flat in the second quarter and did contract in the first quarter — is an indicator of deflationary pressure in the pipeline.

Unit labor costs fell 0.6 percent in the third quarter, more than the 0.3 percent contraction expected by economists, suggesting that there may in fact be some deflationary forces in the economy. This is likely to be interpreted as yet another “green light” for the Federal Reserve’s program of quantitative easing. Backed by the idea of ongoing Fed stimulus — Fed chair nominee testified before the Senate on Thursday and indicated ongoing support for the program — U.S. equity markets advanced in afternoon trading.

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