Labor productivity Q4 2023

Labor productivity continues to shine


Nonfarm business sector labor productivity posted another solid advance in Q4 2023, rising 3.2%, as economic output rose 3.7% and hours worked increased a more modest 0.4%. This represents the third consecutive quarterly gain of more than 3% – a feat that occurred once in the decade that preceded the pandemic (in 2019).

 

Encouragingly, the annual trend in productivity growth continues to firm with growth accelerating to 2.7% year over year (y/y) in Q4 2023. Excluding the recession-induced distortions (when productivity surges because labor is cut more rapidly than output), this is the strongest reading since Q4 2019, and before that the strongest reading since 2005.

 

Stronger productivity helped offset solid growth in compensation. Indeed, while compensation increased a solid 3.7%, unit labor costs only rose 0.5%. This is the perfect illustration of how stronger productivity can lead to non-inflationary growth. Unit labor costs are now rising at a modest 2.3% y/y clip, down from a peak of 6.5% in 2022, and in line with the pre-pandemic pace of inflation. 

 

During the post-Federal Open Market Committee (FOMC) press conference, Fed Chair Jerome Powell confirmed our view that the US economy is benefiting from the “holy grail” of noninflationary growth in saying, “I am not so worried about [strong growth]. We have had inflation come down without a slow economy, and without important increases in unemployment.” Still, he remained much more skeptical than we are about the durability of this productivity rebound saying, “My guess is that we may shake out and be back where we were."

 

As we have been stressing for the past eight months, the revival in productivity is encouraging for the broader inflation and economic outlook. If companies 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 business executives confirm this increased focus on productivity. I discussed this in my recent LinkedIn newsletter1:

 

The avid reader will recall that back in July of last year, this newsletter (The seven wonders of a unique global business cycle)2 made the case that we were likely on the verge of a productivity rebound. Turns out we were right! Why?
 

  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 AI (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.

The views reflected in this article are the views of the author(s) and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.