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Chapter 17: Labor Productivity: Wages, Prices, and Employment

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1. The Productivity Concept

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Labor Productivity

Labor Productivity =Total product (real

GDP)Number of worker hours

Productivity IndexYear 2

=ProductivityYear 2

ProductivityBase Year

* 100

Productivity can be calculated using data from different years to form an index of productivity relative to a base year.

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BLS Index

0

20

40

60

80

100

120

140

1960 1965 1970 1975 1980 1985 1990 1995 2000

Out

put P

er W

orke

r

Index

• The BLS productivity index is calculated by dividing real output in the private sector by the number of hours employed in the private sector.• The index understates productivity growth in that improvements in the quality of output are not taken into account.

• The index implies that labor alone is the cause of the rise in productivity. Other factors such as increases

in the amount of capital and technological

progress also play a role.

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2. Importance of Productivity

Increases

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Productivity increases are important because: Productivity growth is the basic source of

increases in real wages and living standards.

Productivity growth is an anti-inflationary force in that it offsets increases in nominal wages.

Importance of Productivity Increases

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Productivity and Real Compensation

0

20

40

60

80

100

120

140

1947 1957 1967 1977 1987 1997

Inde

x (1

992=

100)

Output per hour Real hourly compensation

• Because real output is real income, the growth of real output per worker hour and the growth of real compensation per

hour are very closely related.

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If nominal wages rise at a faster rate than productivity rises, then the labor cost per unit of output (unit labor cost) will rise.

If nominal wages rise at a slower rate than productivity rises, then the labor cost per unit of output will fall.

Since labor costs are between 70 and 75 percent of total production costs, higher unit labor costs will lead to higher inflation. Other factors also affect the inflation rate

such as the money supply.

Inflation and Productivity

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3. Long-Run Trend of Labor Productivity

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Importance of Causes of Productivity Growth

32%

15%

53%

Increased Efficiency Improved Labor QualityQuantity of Capital

• Jorgenson and Stiroh estimate that about one-half of the

productivity growth over the 1959-2001 period was due to increases in the quantity of capital. The other half was

due to increases in labor quality and

improvements in efficiency.

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Increases in Educational Attainment

0%10%20%30%40%50%60%70%80%90%

1960 1970 1980 1990 2002

Perc

ent

Percent High School Graduate or More

Percent College Graduate or More

• One reason that labor quality has increased is that the educational attainment of the population (aged 25 and older) has

increased over time.

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A higher amount capital increases labor productivity. For example, one can dig more dirt per

hour with a bulldozer than with a shovel. Between 1959 and 1998, the amount of

capital per worker hour went up by about 50 percent.

Increased Quantity of Capital

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Increased efficiency can result from Technological progress including

improved capital and business organization and managerial techniques.

Greater specialization as the result of scale economies.

Reallocation of labor from less productive to more productive sectors.

Changes in the legal, environmental conditions, public policy For example, lower trade barriers.

Increased Efficiency

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4. Cyclical Changes in Productivity

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Labor productivity is procyclical. Productivity rises in economic booms and

falls during recessions. Productivity is procyclical because

In a recession, a firm’s sales decline more rapidly than its units of labor Some managers are a fixed cost of labor Firms are reluctant to fire workers with

specific training since they lose their training investment.

Business Cycle and Productivity

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Capital is not fully utilized during recessions and so productivity falls.

During recessions, demand falls the most in the high productivity durable manufacturing goods sector. The share of manufactured goods in total

output falls, and so productivity falls during recessions.

Business Cycle and Productivity

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The fall in productivity during recessions makes them more severe. The productivity decline raises unit labor

costs, which lowers profits. Lower profits decrease investment

spending which intensifies the downturn. The reverse occurs during economic

recoveries.

Implications

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Cyclical changes in productivity also have implications for economic policy. Declines in productivity contribute to

cost-push inflation by raises unit labor costs.

A cyclical rise in productivity during the early stages of a recovery permits more expansionary policy since it lowers unit labor costs.

Implications

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Questions for Thought:1. Describe and explain the cyclical changes that

occur in labor productivity. Of what significance are these changes?

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5. Productivity and Employment

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Compensation rises more or less evenly across industries, even though output per hour varies greatly by industry. Labor supply shifts prevent wages from

diverging in the various industries. This implies rising per unit costs and

reduced output and employment in industries with slow productivity growth, and falling per unit costs and output and employment in industries with high productivity growth.

Demand Factors Constant

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Productivity and Employment, 1991-2001

-15%

-10%

-5%

0%

5%

10%

15%

-5% 0% 5% 10% 15% 20%

Productivity (annual percent change)

Em

ploy

men

t (an

nual

per

cent

cha

nge)

• Variable demand factors confound the actual relationship between productivity growth and

employment within industries.

• The data reveal no systematic

relationship between industry productivity growth

and industry employment growth.

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Questions for Thought:1. How do you account for the close correlation

between changes in the rate of productivity growth and changes in the real wage rates for the economy as a whole? Does this relationship also hold true on an industry-by-industry basis? Explain.

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6. The “New Economy”

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Labor Productivity Growth Rates, 1948-2003

0

0.5

1

1.5

2

2.5

3

3.5

1948-1973 1974-1990 1991-1995 1996-2003

Perc

ent

• Productivity growth surged in the second half of the 1990s, after being relatively low for the prior two decades.

• No consensus exists as to whether this

increase in the productivity growth

rate is a part of a new long-run trend or simply a temporary aberration.

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Faster increases in the quantity of information such as computers may have increased productivity growth.

Oliner and Sichel's analysis indicates 63 percent of the acceleration in productivity growth between 1991-95 and 1996-2001 was due to increases in the use of information technology

Increased spending on other capital contributed very little to the acceleration in productivity.

Increased Use of Information Capital

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Technological progress and efficiency, particularly in information technology, may have increased the productivity growth rate. Oliner and Sichel find that 33 percent of

the productivity speedup between 1991-95 and 1996-2001 was due to increased efficiency in the production of semiconductors Another 8 percent was caused by

increases in the productivity of making other information technology products

Increased Technological Progress and Efficiency

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EndChapter 17