Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin Chapter 17 Labor Productivity: Wages, Prices, and Employment

The Productivity Concept

17-3 Labor Productivity = Total product (real GDP) Number of worker hours Productivity Index Year 2 = Productivity Year 2 Productivity Base Year * 100 Productivity can be calculated using data from different years to form an index of productivity relative to a base year.

17-4 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.

Importance of Productivity Increases

17-6 Importance of Productivity Increases oProductivity 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.

17-7 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.

17-8 Productivity change in the nonfarm business sector,

17-9 Productivity change in the manufacturing sector,

17-10 Labor Productivity Growth Rates, 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.

17-11 Inflation and Productivity oIf nominal wages rise at a faster rate than productivity rises, then the labor cost per unit of output (unit labor cost) will rise. oIf nominal wages rise at a slower rate than productivity rises, then the labor cost per unit of output will fall.

17-12 Inflation and Productivity oSince 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.

Long-Run Trend of Labor Productivity

17-14 Importance of Causes of Productivity Growth Jorgenson, Ho, and Stiroh estimate that about one-half of the productivity growth over the period was due to increases in the quantity of capital. The other half was due to increases in labor quality and improvements in efficiency.

17-15 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.

17-16 Increased Quantity of Capital oA 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.

17-17 Increased Efficiency oIncreased 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

17-18 The New Economy oSince 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 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.

17-19 Extra Slides

Cyclical Changes in Productivity

17-21 Business Cycle and Productivity oLabor productivity is procyclical. Productivity rises in economic booms and falls during recessions. oProductivity 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.

17-22 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.

17-23 Implications oThe 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.

17-24 Implications oCyclical 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.

17-25 Question for Thought 1. Describe and explain the cyclical changes that occur in labor productivity. Of what significance are these changes?

Productivity and Employment

17-27 Demand Factors Constant oCompensation 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.

17-28 Demand Factors Constant oThis 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.

17-29 Productivity and Employment, 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.

17-30 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.

The “New Economy”

17-32 Use of Information Capital oIncreased 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 was due to increases in the use of information technology. The corresponding figure for was 23 percent.