Meet the Author

Paul W. Bauer |

Senior Research Economist

Paul W. Bauer

Paul Bauer is a former senior research economist at the Federal Reserve Bank of Cleveland.

Meet the Author

Michael Shenk |

Research Assistant

Michael Shenk

Michael Shenk was formerly a research assistant in the Research Department of the Federal Reserve Bank of Cleveland. His work focused on international topics and housing-market indicators.

07.30.09

Economic Trends

Productivity in the Recession and Going Forward

Paul Bauer and Michael Shenk

In contrast to previous postwar recessions that tended to see sharply lower labor productivity growth, if not outright declines, the 2001 and the current recessions have had relatively strong labor productivity growth. In 2001, year-over-year productivity never dropped below 2.0 percent. In the current recession, productivity has remained over 1.9 percent. The sustainability of this productivity growth has implications for monetary policy, the affordability of the Federal deficit, and ultimately our living standards in the long run.

Gains in labor productivity (output per hour) come from three sources: increasing the amount of capital per worker (capital intensity); increasing workers’ average level of skill, education, and training (labor composition); and a residual (multifactor productivity) that picks up economy-wide gains in knowledge and organizational methods not captured by the previous two effects. Only annual estimates are available for the breakdown in labor productivity. The post-1995 resurgence in labor productivity has been spurred largely by capital intensity and multifactor productivity. However, the growth for 2007 to 2008 was fueled more by capital intensity and a bit less multifactor productivity.

Labor Productivity for Private Nonfarm Business

   Annual growth rate
   1987-1990 1990-1995 1995-2000 2000-2007 2007-2008
Output per hour of all persons
1.5
1.6
2.5
2.5
2.8
Contribution of capital intensity
0.6
0.6
1.2
0.9
1.6
Contribution of labor composition
0.4
0.5
0.2
0.2
0.1
Multifactor productivity
0.5
0.5
1.1
1.4
1.1

Note: Multifactor productivity plus contribution of capital intensity and labor composition may not sum to output per hour due to independent rounding.
Source: Bureau of Labor Statistics.

In expansions, the source of productivity gains from capital intensity comes from firms investing at a faster rate than they are adding workers. Unfortunately, in this recession gross private domestic investment is currently falling over 20 percent on a year-over-year basis, so the gains from capital intensity are a consequence of it being easier for firms to shed workers than capital. While this process boosts the amount of capital available per worker, it is not sustainable in the long run. Firms are being forced to run leaner and that should help boost productivity once demand recovers.

Labor composition, after adding 0.4-0.5 percentage points from 1987 to 1995, has only added a modest 0.2 percentage point to labor productivity since 1995 and only 0.1 percentage point from 2007 to 2008. As always happens in recessions, laid off workers—and young people that might have entered the labor market—choose instead to enroll in further education and training programs. Taken alone, this will boost the contribution from labor composition in the future. However, what matters for productivity is how much output a worker produces, and for re-employed workers, they frequently move to new occupations or a different industry where they may be less productive than in their previous employment. As the overall effect of labor composition has been small in recent years, the economy-wide effect of this phenomenon should be small.

The third source of labor productivity, multifactor productivity, does continue to show a pro-cyclical pattern. In the mild recessions of 1991 and 2001, it did not dip very much from its previous rate, and that has been the case for the current recession. The last two times we had prolonged periods of structural reallocations, 1974-1975 and 1980-1983, multifactor productivity took a much bigger hit. Viewed optimistically (remember that we do not have estimates for 2009 yet) the flow of innovations appears to be continuing to make their way to the market.