For the Fed’s Consideration, Higher Productivity Growth10th March 2019
Neil Irwin had a good piece discussing the slower job growth reported for February, along with more rapid wage growth. He argued that as a result of recent evidence of slowing growth (not so much from this jobs report) the Fed may be inclined to leave interest rates where they are, or possible even lower them. However the pick up in wage growth may lead the Fed to worry about inflation and therefore raise interest rates.
While Irwin notes the pick up is modest, so it’s not obvious it will lead to higher inflation (also given the large shift from wages to profits in the Great Recession, higher wages could come out of the profit share rather than being passed on higher prices), there is another important factor in the equation. Productivity growth, which directly reduces the cost of an hour of labor, increased to 1.8 percent last year. This is 0.5 percentage points above its trend rate since 2005. (It is still well below the 3.0 percent pace from 1995 to 2005 and from 1947 to 1973.)
Productivity data are notoriously erratic, so it is entirely possible that the 2018 pickup will turn out to be an aberration, but if faster growth is sustained, it would mean that the economy could support a more rapid pace of wage growth. There are some complicating index issues, but as a first approximation, if productivity growth is 1.8 percent, workers can have 3.8 percent nominal wage growth, and we could still keep at the Fed’s 2.0 percent inflation target.
As some of us have argued, it is reasonable to expect that productivity growth will accelerate as the labor market tightens. The basic logic is that when labor gets scarce, employers have an incentive to try to use less of it. That means productivity growth.
There are three channels through which this can work. The first is a simple composition one. When labor becomes more expensive, the least productive jobs go unfilled. My favorite example is the midnight shift at a convenience store. The productivity of this worker has to be very low. (How many people come in to buy grocery items at 2:00 in the morning?) In a tight labor market, the convenience store closes at midnight and opens in the morning. By eliminating the least productive jobs, average productivity rises.
The second channel is that employers may be able to reorganize the workplace to do more with fewer workers.Even though our textbooks tell us that employers always have the optimal mix of labor and capital inputs and workplace organization, there are actually places where workers are not employed in the most efficient manner. The bosses may not care when workers are plentiful, but when the bad boss sees all his workers leaving for better jobs, he may think about trying to improve his workplace.
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