One Sign That U.S. Productivity Growth Is Poised to Shoot Higher

A tight labor market bodes well for productivity growth.

On a quiet summer morning in markets, one data point testified to the U.S. economy's most enduring problem, while another gave reason to expect an improvement in this area in the years to come.

Productivity growth was negative for the third consecutive quarter, defying economists' expectations for a pick-up of 0.5 percent.

Meanwhile, the National Federation of Independent Business reported that the share of employers who say they're having trouble filling job openings remains relatively high.

Like anything else, the cost of labor gets higher as it gets more scarce. This dynamic should incent businesses to start spending more on capital, rather than continuing to bid up wages, in order to boost production. Capital deepening, in turn, is a key driver of productivity: when workers have more/better/newer equipment, they're generally able to produce more output per hour.

As such, Nordea Markets Chief FX Strategist Martin Enlund drew attention to the relationship of a tightening labor market eventually leading to higher productivity.

Source: Martin Enlund/Bloomberg

"If labour scarcity rises - and/or labour quality weakens, this greater cost-of-hiring (of L) is the same as a relative drop in the cost of real capital (K)," he wrote. "A growing capital stock would be consistent with greater productivity growth."

Renaissance Macro Research Head of U.S. Economics Neil Dutta previously published a version of this chart shortly after the publication of productivity statistics for the fourth quarter 2015. 

"If the deep recession is a reason that productivity is weak, running the economy at full employment can yield benefits in the longer run," he added. "Full employment brings higher costs. Thus, firms have more of an incentive to find efficiencies."

Bespoke Macro Strategist George Pearkes aptly summed up the American experience from the onset of the financial crisis until the present day in a pair of tweets this morning:

Source: Twitter


Source: Twitter

The seeds of higher productivity are being sown by a tightening U.S. labor market, but it may take a while for them to bloom, as suggested by the five-year lag between the two variables in the above chart.

"It must take quite some time for the aforementioned dynamic to fully play through, though," cautioned Enlund. "The labor market gap must close before this relative labor to capital shift occurs."

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