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Economic Update | The Next Productivity Boom?

–and labor force shows expansion

By Dr. Uric Dufrene, Sanders Chair in Business and Professor of Finance, Indiana University Southeast

The BLS released the quarterly report on labor productivity last week and it indicated that labor productivity increased 6.6% in the fourth quarter.   Output increased 9.2%, but hours worked only increased by 2.4%.     Labor productivity did see a bounce during the first year of the pandemic and has been fluctuating back and forth for the past year.   The overall trend, however, has been upward.

Productivity is particularly important now because of the price pressures that producers are seeing.   Productivity will allow producers to keep a lid on unit costs and serve as overall headwinds to inflation.  As an example, the last BLS report indicated that hourly compensation increased by 6.9% in the fourth quarter, but productivity increased by 6.6%.   The net effect was a .3% in unit labor costs.     Productivity will be the key for employers to sustain higher wages.

While we’ve already observed gains to productivity during and after the recession, we have yet to realize additional gains to productivity.   What are some of the clues pointing to gains in productivity that have yet to materialize?

First, we can look at the investment in industrial machinery.   New orders for manufacturing durable goods industrial machinery are at an all-time high, almost double the level that existed coming out of the recession.    As a comparison, new orders for industrial machinery coming out of the Great Recession never caught up with the level that existed just prior to that start.   That is, following the Great Recession, new orders for industrial machinery did not move past pre-Great Recession levels until this past year.   That is a stunning comparison.    This significant acceleration in industrial machinery is not just about meeting demand.    Manufacturers are making significant investments to increase efficiencies with the ultimate objective of increasing productivity.   Gains to productivity following these investments will pave the way for higher sustained wages, along with a stronger focus on the importance of skills.   Simply speaking, it takes a greater skill set to operate a backhoe than it does a shovel.

We are also observing significant investments in software and information processing equipment.  Following the Great Recession, there was a decline in both categories, and it took almost three years to return to the level of investment that existed at the onset.  In the most recent Covid recession, investment in both software and other information processing equipment has been accelerating since last year.   Organizations are making investments in digital technologies that will conserve costs and boost productivity.  At least, that is where the data are pointing.

Boosting productivity due to the installation of new machinery and software does not happen overnight.   The company must do the research, meet with vendors, and make a final decision.  The rollout of the new equipment and software requires training and implementation could even come in phases.   The point is that productivity gains will not show up in one report but over time.

We close with a brief word on the labor force.  The last national employment report was solid on the payrolls front.   The headline number of 467,000 jobs added came in significantly above estimates. The one big takeaway was on developments in the labor force participation rate.   As we have pointed out in previous columns, an available labor force is the key for additional job creation.  Last month, the nation’s labor force increased from 61.9% to 62.2%.   It was the largest increase in the participation rate since June 2020, just as the nation was exiting the recession.  As we see gains to the labor force participation rate, this will also support positive payroll growth.   We can also expect additional gains to the labor participation rate this year.  Approximately 3 million prime-age workers are not in the labor force but indicate that they want a job now.  As we move past the adverse impacts of Omicron on labor supply, and as workers exhaust the benefits of government stimulus, we will see an expanding labor force.

Data sources:  BLS Employment Situation, Census Advance Report Durable Goods, FactSet, FRED, BLS Productivity, and Costs.

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