Aug 11, 2016 - 9:00am

Declining Labor Productivity Both a Symptom and a Warning

Former Senior Vice President, Economic Policy Division, and Former Chief Economist

It would only be slightly hyperbolic to say productivity growth is the mother’s milk of prosperity. Other metrics also are relevant, like employment and the growth and distribution of net wealth, but just about any other data one might use to describe a nation’s changing prosperity relates to or derives from labor productivity. If you’re looking for the single most important indicator of current and future prosperity, you just can’t do better ... which is why we should be worried, because this signal is flashing bright red.

Unlike so much economic data, labor productivity – the amount of output per hour – is one of the easiest to derive and understand. In calculation, one simply takes the ratio of total output adjusted for inflation to a measure of the amount of labor employed, and then follow how this ratio changes over time. When labor productivity is rising, it means rising labor compensation should soon follow. It means workers and firms are becoming more competitive in global markets. And when labor productivity is declining, it means just the opposite.

Labor productivity as calculated by the Bureau of Labor Statistics has declined for three quarters straight. It has declined for four of the last seven quarters. Averaged over the last three years, labor productivity grew a puny 0.15 percent. Over the last two years it grew even slower at 0.1 percent. Over the last year it shrank by 0.1 percent. In short, labor productivity is painting an ugly picture getting steadily uglier.

Labor productivity growth is interesting in another respect as it distills down into one easy-to-understand number the sum total of all that we do right as a nation and all that we do wrong economically.  Most especially, it distills down the net effects of government policies in recent years on economic efficiency and growth.  

Of course, in the short run labor productivity can rise or fall abnormally rapidly due to business cycle conditions. During a recession, businesses typically try to hold on to their workforces as much as possible to avoid subsequent hiring costs and to be able to take full advantage of the expected upturn, and this can cause reported labor productivity to decline. Likewise, during a recovery businesses use the slack from their excess workforces held through the recession to increase production and so productivity growth typically spikes. These transitory developments tell us little about the long term.

The current dismal labor productivity figures do not reflect cyclical conditions. Coming toward the end of the current administration these figures aptly and primarily describe the net effects of the administration’s economic policies, most especially its hyper-active regulatory policies. On Aug. 8, the American Action Forum (AAF) released a study summarizing those policies.

According to AAF, the administration has issued an average of 81 major regulations a year, where major regulations are defined as costing at least $100 million, for a total so far of over 600 major regulations costing over $743 billion according to the regulators’ own estimates though the real cost could be significantly higher. At the start of the year the president indicated he would push his administration to be very aggressive in accelerating the outflow of regulations in the time remaining, so the economic drag from regulations would be expected to intensify. 

Regulations have costs that go far beyond the simple calculations presented. They also create uncertainty among affected businesses as they wait for the regulations to come out, become final, and then become internalized within the business. Perhaps even more important, when businesses are subject to such an onslaught of regulations in complete disregard to the economic damage they inflict, and especially in combination with other policies such as the administration’s enacted and proposed anti-growth tax policies, the net result is to create at least the appearance of an antagonistic attitude toward businesses. Businesses can then become overly cautious and defensive and these consequences appear in the declining business investment in recent quarters.

The administration has advanced its agenda with little regard to economic consequences, and the results are now apparent most especially in declining labor productivity. The next administration and the next Congress need to do significantly better. As Larry Summers recently wrote in a wakeup call to his progressive friends, “The reality is that if U.S. growth continues to have a 2 percent ceiling, it is doubtful that we will achieve any of our major national objectives.”

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About the Author

About the Author

Former Senior Vice President, Economic Policy Division, and Former Chief Economist

Dr. J.D. Foster is the former senior vice president, Economic Policy Division, and former chief economist at the U.S. Chamber of Commerce. He explores and explains developments in the U.S. and global economies.