Labor Productivity in the U.S. Economy

Maintaining a Growth Mindset: Labor Productivity in the U.S. Economy

Is the United States economy on the cusp of a labor productivity boom?

Labor productivity is the key to a healthier, wealthier society. In essence, real wages (wages adjusted for inflation) can increase when labor productivity is on the rise without stoking inflation. After nearly 15 years of depressed productivity growth, measures of labor productivity in the U.S. have increased to levels we have not seen since the 1990s. I am hopeful (if not cautiously optimistic) that this trend may continue to support healthier economic growth through the 2020s.

To boost my own productivity in writing this blog, I asked ChatGPT for a definition of labor productivity and to specifically address the impact that it has on wages and inflation dynamics:

“Labor productivity measures the amount of goods and services produced per hour of work. It reflects how efficiently labor inputs are used in the production process. When productivity rises, businesses can produce more without proportionally increasing labor costs, allowing them to maintain or grow profits while potentially raising wages.

Higher productivity is crucial for sustainable wage growth because it offsets the cost of higher pay. Without productivity gains, wage increases can lead to higher production costs, which businesses often pass on to consumers, fueling inflation. Conversely, strong productivity growth helps stabilize inflation by keeping unit labor costs in check.

In the long run, robust productivity growth supports economic expansion, enhances living standards, and reduces inflationary pressures. For policymakers, it’s a key focus area, as improving productivity enables wage gains without compromising price stability—a cornerstone of healthy economic development.” -ChatGPT

In the chart below, I plot the index value of labor productivity (the up-trending line, left scale) and isolate the average year-over-year growth by quarter (the flat lines, right scale) for different periods of above or below average growth since the late 1980s:

The late 1990s was a period of exceptional growth in labor productivity with an average year-over-year increase of 3.1%, followed by 15 years of depressed productivity growth averaging 1.5%. The 2010s were often characterized by economists like Tyler Cowen as the “Great Stagnation”.

Let’s hope that the Great Stagnation is over. Going back to the start of 2023 and through the 3^rd quarter of 2024, the U.S. has averaged labor productivity growth of 2.4%. In fact, Jerome Powell, the chairman of the Federal Reserve, specifically cited strength in labor productivity in a recent speech on November 14^th:

“Improving supply conditions have supported this strong performance of the economy. The labor force has expanded rapidly, and productivity has grown faster over the past five years than its pace in the two decades before the pandemic, increasing the productive capacity of the economy and allowing rapid economic growth without overheating.”

A return to >2% labor productivity growth on a sustained basis would be a welcome development. Getting “more for less” is the essence of real wealth creation and results in a virtuous cycle of real wage gains and business investment.

How does labor productivity in the U.S. compare to other advanced economies? From JP Morgan’s recent “Eye on the Market”, the charts below show a striking difference in labor productivity between the U.S. and EU area over the last 7 years:

The disparity in productivity growth between the U.S. and EU underscores the role of structural economic differences, such as labor market flexibility, investment in innovation, and policy responses to economic challenges, which have allowed the U.S. to maintain a competitive edge on the global stage.

These structural differences and healthier labor productivity translate into stronger real GDP growth per capita in the U.S. relative to other developed economics. This chart from Peter Farac’s blog shows how the U.S. significantly outperformed Australia, Canada, United Kingdom, and the Euro area in GDP per capita growth since 2022:

It’s not encouraging to see productivity and growth stagnate in other developed economies around the world. However, it’s important to see that a large and advanced economy like the U.S., where many economists had assumed the “low-hanging fruit” of productivity had been picked, is still capable of >2% annual labor productivity growth.

As the U.S. continues to demonstrate resilience in labor productivity, the potential for a sustained boom could redefine the economic landscape of the 2020s. Achieving growth rates above 2% not only enhances real wage growth and business investment, but also provides a crucial buffer against demographic challenges like aging populations and other global economic pressures.

However, realizing this potential will depend on maintaining a conducive environment for technological adoption, workforce development, and policy support. While the road ahead may have its challenges, a renewed focus on productivity offers a promising path toward a healthier, wealthier, and more equitable society. The question now is how businesses, policymakers, and individuals can collectively seize this moment to build lasting economic momentum.

 

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