Three Reasons Why U.S. Productivity May Be on the Verge of Taking Off
The stars are aligning for a game-changer for workers, corporate america, and the Fed: A rise in U.S. productivity.
Tightening labor markets, a strong dollar, and looming rate hikes all pave the way for a rise in the efficiency of U.S. economic output, Deutsche Bank AG strategists led by Binky Chadha wrote in a report on Tuesday. "The historical drivers look to be aligning for an inflection up in productivity growth," the analysts write. "Throughout history productivity growth responds strongly to economic conditions, i.e., the corporate sector raises productivity when it has to or needs to."
We note that productivity increases and real wage increases are strongly positively correlated. The correlation of course does not establish causation and while many see low productivity growth as the driver of low wage growth, we see a tight labor market encouraging wage growth that in turn fosters productivity. growth.
In addition, dollar appreciation reduces the relative competitiveness of U.S. firms, and thus creates an incentive for companies to ramp up productivity to defend margins and market shares, Chadha's team says. While the need to boost productivity to maintain competitive standing becomes more pressing in this environment, it's also possible that the rising greenback could trigger companies to boost investment outside the U.S. to take advantage of the change in relative unit labor costs. The dollar is up by a third in trade-weighted terms from its cycle low, boosting productivity prospects if historical relationship holds true.
The analysts observe that the last time the U.S. enjoyed a rapid productivity phase was in the late 1990s, which featured a tight labor market and a rising dollar,
Fears that the U.S. economy is in the grips of secular stagnation — the view that economic growth and the natural rate of interest is structurally low or in negative territory — have been fed by febrile U.S. productivity data. U.S. productivity growth — a measure of the change in output per hour worked — was negative for the third consecutive quarter and U.S. quarter-on-quarter productivity growth is significantly below its long-run average of 2.2 percent.
In fact, the current slow productivity cycle is in its 13th year, according to the Deutsche analysts, which take a sweeping view of the long-run average growth of worker output since the 1950s in the report.
In addition to the tailwinds for productivity driven by strengthening real wages and a stronger dollar, "interest rate normalization should see financials and overall productivity rise," the analysts say, noting that the productivity growth among financials tends to outstrip that of the business sector as a whole when the 10-year Treasury yield moves higher.
Whether any uptick in productivity will be a dead-cat bounce or a spirited rebound is far from clear — the analysts don't take a view on the outlook for structural factors that have been cited as headwinds to productivity growth, including the aging population and failure of new technologies to boost output in recent years.
A cyclical uptick in U.S. productivity would boost confidence among Fed officials that the U.S. economy is strong enough to withstand interest-rate hikes, and that any ensuing tightening of financial conditions is unlikely to derail corporate investment. Conversely, further evidence that U.S. productivity is structurally weak would trigger Fed officials to further downgrade potential growth estimates and their forecast for how high rates will eventually get, known as the long-term natural rate.
Chadha & Co. strike a different note from a July 29 report by the bank's own rate strategy team, led by Dominic Konstam that warned that a slowdown in payroll growth as the economy approaches full employment, could rattle firms' outlook for demand growth and reduce their willingness to invest.
"The logic is quite simple: the corporate sector is unlikely to increase investment in the absence of strong (global) final demand, and investment has historically been a requisite for rising productivity," wrote Konstam, in an August report. Where Chadha's team sees any lift in interest rates and the greenback as positive for productivity, Konstam's team would be inclined to view these developments as headwinds for private investment.
So while the stars may be aligning for an acceleration in productivity growth, a resolution to this issue that's long vexed the U.S. economy is far from written in the stars.