Monthly Market Commentary

Productivity and the Economy

Philip Blancato, Chief Market Strategist, Advisor Group

Roughly eighteen months ago the global economy was confronted with an existential threat to growth not seen in over 100 years, a global pandemic. Coronavirus caused economies across the world to shut down and forced businesses to reassess their business models. The actions taken by companies in response to the virus have had far reaching effects, impacting not only major indicators of economic health like inflation and the labor market, but also components that are not as widely discussed, like productivity. Although productivity is not looked at in as much detail as other economic factors, we believe it’s important to analyze the material change that has occurred in that area in recent years, as it could have a significant impact on the U.S. economy moving forward. The U.S Bureau of Labor Statistics tracks two key measures of economic productivity, which are labor productivity and multifactor productivity, both of which are key to economic growth. Labor productivity compares the number of hours worked to produce goods and services to the amount of goods and services produced.1 Multifactor productivity is a more comprehensive economic measurement that compares the total amount of goods and services produced, or output, to the number of inputs needed to produce those goods and services. Inputs can include labor, capital, energy, materials, and purchased services.

Productivity enhancements were key for American businesses during the post World War II era, with the development and implementation of new technologies and processes accounting for much of the economic prosperity during this period. During the post-WWII era, corporate profits rose roughly 6.4% annually while labor costs climbed virtually in lockstep coming in at 6.3%. Simultaneously, corporate pretax profits increased 6.5%, which can be attributed almost exclusively to the 2.7% annual climb in productivity, or increases in output, during the period.3 Flashing forward to today, productivity enhancements have been further accelerated by rapid technological developments.

 

Moore’s law is an observation of computing power which states that the capabilities and speeds of computers can be expected to double every two years. Under that assumption, we can expect the ability for companies to replace or automate bottle necks and cost drivers in their business models to increase exponentially. In the last year alone, labor productivity has increased at an annualized rate of 3.1%. This is more than double the rate it increased during the previous business cycle, which was 1.4%. In the second quarter of 2021, productivity in nonfinancial sectors jumped to 5.4%, while hourly compensation rose at a rate of 2%.

If productivity and the implementation of cost reduction tools such as digitizing business models continue to increase at the rate experienced over the last year, the U.S economy could stand to benefit greatly. Researchers at McKinsey Global Institute have found that economies that are able to effectively embrace digital connectivity and business models have the potential to increase their GDP at a rate between one and five percent by 2030.

Productivity enhancements are not only important to economic growth and corporate profits but can also have an impact on inflation. The importance of increasing productivity to control inflation is potentially greater today than it was during the 1970s, the JULY 2021 Productivity and the Economy Philip Blancato, Chief Market Strategist, Advisor Group MARKET ANALYSIS last time the U.S experienced hyperinflation. Unlike the 1970s, companies today compete on a much more global scale and are limited in their ability to increase prices, as it creates the potential for them to be displaced by foreign companies. It is imperative for companies to take a focused approach to increasing productivity in order to combat increased input costs such as labor or commodities. Increases in productivity, or more output per unit of input, help to grow the economy and create avenues for governments, stockholders, and employees to capture a larger share of the growth.6 Increasing productivity acts as a deflationary force in the economy. Additionally, it solidifies the claim that inflation may be transitory and that once economic productivity fully recovers and eventually surpasses pre-pandemic levels, we will enter a period of strong economic growth.

Economic Definitions

Multifactor Productivity: Multifactor productivity (MFP), also known as total factor productivity (TFP), is a measure of economic performance that compares the amount of goods and services produced (output) to the amount of combined inputs used to produce those goods and services. Inputs can include labor, capital, energy, materials, and purchased services.

Labor Productivity: Labor productivity is a measure of economic performance that compares the amount of goods and services produced (output) with the number of hours worked to produce those goods and services.

GDP: Gross domestic product (GDP) measures the final market value of all goods and services produced within a country. It is the most frequently used indicator of economic activity. The GDP by expenditure approach measures total final expenditures (at purchasers’ prices), including exports less imports. This concept is adjusted for inflation.

Disclosures:

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https://www.bls.gov/lpc/
https://www.bls.gov/mfp/
https://www.bloomberg.com/opinion/articles/2021-07-01/how-labor-shortages-help-profits-and-hurt-inflation
https://www.bloomberg.com/opinion/articles/2021-07-01/how-labor-shortages-help-profits-and-hurt-inflation
https://www.mckinsey.com/business-functions/risk/our-insights/covid-19-implications-for-business#
https://www.bloomberg.com/opinion/articles/2021-07-01/how-labor-shortages-help-profits-and-hurt-inflation

 

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