Labor productivity Q1 2024

Robust productivity momentum despite slower growth in Q1 

Nonfarm business sector labor productivity cooled in Q1 2024, rising 0.3% quarter over quarter (q/q) in annualized terms, as economic output rose 1.3% and hours worked increased 1.0%. This slowdown comes on the back of three consecutive quarterly gains of more than 3% – a rare feat that occurred only once in the pre-COVID 19 decade (in 2019). As part of benchmark revisions going back to 2015, productivity growth was revised up 0.1 percentage point (pt) in 2023.
 

Encouragingly, the annual trend in productivity growth accelerated 0.2pt to 2.9% year over year (y/y) in Q1 2024. This is the strongest reading since Q4 2019, and before that, the strongest reading since Q1 2005 – excluding the recession-induced distortions when productivity surges because labor falls faster than output.

 
Slower sequential momentum in productivity growth in Q1 meant that unit labor cost picked up. Compensation increased a solid 5.0% q/q annualized, pushing unit labor costs up 4.7% – the strongest gain in a year. 
 

Still, robust productivity momentum continues to drive non-inflationary economic growth. The annual pace of growth of unit labor costs cooled 0.6pt to 1.8% y/y in Q1, down from a peak of 6.5% y/y in 2022, and the slowest pace since Q2 2021. The pace of unit labor costs is now slightly below the pre-pandemic pace and as such continues to point to a disinflationary environment.

 
During the post-Federal Open Market Committee (FOMC) press conference, Fed Chair Jerome Powell reiterated that the Fed doesn’t target wage growth and implicitly indicated that stronger productivity growth could continue to deliver the “holy grail” of non-inflationary economic growth, saying: “Remember last year, we saw really strong growth, a tight labor market and historically fast decline in inflation. I wouldn't rule out that something like that can't continue.”

As we have been stressing for a year, the revival in productivity growth is encouraging for the broader inflation and economic outlook. If firms can generate strong productivity growth, they will be able to control costs and protect margins without sacrificing talent in an environment of still-elevated wages and fading pricing power. 

Anecdotal evidence we are picking up from our conversations with CFOs and CEOs across a wide array of sectors confirm this increased focus on productivity. I discussed this in my July 2023 LinkedIn newsletter “The seven wonders of a unique global business cycle”:

1. Boosting labor productivity: With inflation easing and more cautious final demand, business executives are focusing on investments that enhance productivity. This includes retention efforts, long-term training and new technologies to improve labor productivity and efficiency.
    
2. Efficient capital allocation: Paradoxically, higher capital costs are leading to more efficient capital allocation. The end of cheap money means businesses must be more discerning with investments, favoring those that enhance productivity and spur innovation.
    
3. Business dynamism and technological adoption: The pandemic saw a surge in new firms and the potential for wider adoption of advanced technologies like generative artificial intelligence (GenAI), machine learning and quantum computing. Increased R&D and labor mobility are accelerating innovation diffusion and productivity growth.
    
4. Influence of industrial policy: Government initiatives like the Infrastructure Investment and Jobs Act, CHIPS and Science Act and Inflation Reduction Act have encouraged private investment through subsidies and tax credits. Despite traditionally crowding out private investment, these policies have stimulated more investment and productivity growth.”