Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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• 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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Importance of Productivity Increases

o 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.

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Productivity and Real 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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Productivity change in the nonfarm business sector,1947-2010

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Productivity change in the manufacturing sector, 1987-2010

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Labor Productivity Growth Rates, 1948-2008

• 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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Inflation and Productivityo If nominal wages rise at a faster rate

than productivity rises, then the labor cost per unit of output (unit labor cost) will rise.

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

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Inflation and Productivityo 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.

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3. Long-Run Trend of Labor Productivity

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Importance of Causes of Productivity Growth

• Jorgenson, Ho, and Stiroh estimate that about one-half of the productivity growth over the 1959-2006 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

• 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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Increased Quantity of Capital

o A higher amount of 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.

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Increased Efficiencyo 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

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The New Economyo Since 1995, technological progress and

efficiency, particularly in information technology, may have increased the productivity growth rate.• Jorgenson, Ho, and Stiroh find that about

one-fifth of the productivity growth between 1995-2006 was due to increased efficiency in the production of information technology products.

• About a fifth was caused by technological progress and efficiency gains in the rest of the economy.

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Extra Slides

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4. Cyclical Changes in Productivity

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Business Cycle and Productivity

o Labor productivity is procyclical.• Productivity rises in economic booms and

falls during recessions.

o 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.

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Business Cycle and Productivity

• 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.

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Implicationso 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.

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Implicationso Cyclical changes in productivity also

have implications for economic policy.• Declines in productivity contribute to cost-

push inflation by raising 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.

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Question 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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Demand Factors Constant

o 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.

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Demand Factors Constant

o 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.

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Productivity and Employment, 1996-2006

• 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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Question 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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Use of Information Capital

o Increased use of information capital• Faster increases in the quantity of

information such as computers may have increased productivity growth.

• Jorgenson, Ho, and Stroh's analysis indicates 37 percent of the productivity growth between 1995-2000 was due to increases in the use of information technology. The corresponding figure for 2000-2006 was 23 percent.