A CASE STUDY
Productivity
Date Of Announcement
November 7, 2001
Key Economic Indicators
Inflation
(as of November 7, 2001)
+0.4% monthly change in the CPI
September 2001
Date of Next Announcement
December 6, 2001
Announcement
The Bureau of Labor Statistics of the U.S. Department of Labor today reported preliminary productivity data-
-as measured by output per hour of all
Unemployment
Real GDP
5.4% in October 2001
-0.4% annual rate of increase
3 rd quarter, 2001
Productivity 2.7% annual rate of increase
3 rd quarter, 2001
International Trade
Federal Reserve
The trade deficit increased in August
The Federal Reserve lowered the target federal funds rate on November 6
(Click on an indicator above to be directed to persons--for the third quarter of 2001.
The preliminary seasonally-adjusted
most recent case studies.) annual rates of productivity growth in the third quarter were:
2.2 percent in the business sector and
2.7 percent in the nonfarm business sector.
In both the business and the nonfarm business sectors, productivity increases in the third quarter occurred because hours fell more than output. In manufacturing, productivity changes in the third quarter were:
1.1 percent in all manufacturing;
2.5 percent in durable goods manufacturing; and
-1.3 percent in nondurable goods manufacturing.
Bureau of Labor Statistics Press Release, November 7, 2001.
The original press release is available at: http://www.bls.gov/news.release/prod2.nr0.htm
Of these five numbers, the one most often discussed in press and television reports is the rate of increase in productivity in the nonfarm business sector.
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Data Trends
The increase in productivity growth during the third quarter of 2001 was the highest in a year. While the Department of Labor made adjustments in the figures in an attempt to accurately reflect the effects of the terrorist attacks of September 11, it is likely that even these adjusted figures will be subject to future revisions that are larger than normal.
The latest productivity data indicate that businesses are adapting to the slowing growth in total output that has occurred over the past few quarters by adjusting employment and the hours worked. Employment has decreased over the past three months and businesses are reducing the hours worked by each employee as well. In the third quarter, output in the nonfarm business sector decreased (-1.0 %) and hours of employees decreased at a faster pace (-3.6%). The decrease in output by itself lowers productivity. The fact that 3.6% fewer hours were used to produce increases the measured productivity. Thus, the change in productivity was -1.0% + 3.6% = 2.6%. (The numbers do not exactly add up to the reported number, 2.7, due to errors in rounding).
See the latest Unemployment case for a description of recent changes in employment.
In spite of the increase in the most recent quarter, the changes in productivity during
2001 have been less than the changes in the previous three years. The increases in productivity for all of 2000 (annual average of 3 percent) exceeded increases in 1998 (2.6 percent) and 1999 (2.3 percent). The longer run trend in productivity has allowed real
GDP per capita to increase. It also means that wages for workers can increase and can do so without excessive upward pressures on prices. Hourly compensation rose at an annual rate of 4.8 percent during the quarter. Unit labor costs are the costs of labor per unit of output. Thus the increase in unit labor costs is the percentage increase in hourly compensation minus the percentage increase in productivity. Or 4.5% minus (2.7%) =
1.8%.
The increase in unit labor costs provides evidence that there are still some minor inflationary pressures. However the recent slowing growth and the decline in the most recent quarter in real GDP and increase in the unemployment rate to 5.4% provide additional evidence that inflationary pressures are unlikely to be serious.
Productivity Growth in the Future
On November 6, 2001, the Federal Reserve Board lowered the target federal funds rate to its lowest level in 40 years. In their announcement, they made the following statement concerning productivity.
``Although the necessary reallocation of resources to enhance security may restrain advances in productivity for a time, the long-term prospects for productivity growth and the economy remain favorable and should become evident once the unusual forces restraining demand abate.''
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The Federal Reserve recognizes that the terrorist activities on September 11,
2001 prompted increased security measures for businesses across the country.
That increased spending on security means that it will take more hours of labor to produce the same output. Thus the expectation is that productivity will fall as a result of that change. However, the Federal Reserve remains optimistic that productivity growth will continue in the long run after the economy has adjusted to the needed increased security expenses.
Historical Data Trends
From 1950 to 1973, productivity grew at an average annual rate of 2.8 percent. But from 1973 to 1995, growth in productivity slowed to an increase at an annual rate of 1.4 percent. From 1996 to 2000, productivity again increased at an annual rate of 2.5 percent.
The slowdown, beginning in the 1970s, and the increases in the late 1990s are not fully understood. The analysis of the Council of Economic Advisers is that about .47 percent of the recent increase can be explained by the effects of more computers and software being used in many businesses. Dramatic changes in the production of computers themselves helps explain about another .23 percent. The quality of labor
(increased education and more experienced workers) explains about .05 percent.
The rest is not understood. It may be due to cyclical pressures (that is, fewer workers were being added to employment rolls, but those who were working were producing more) and perhaps to the effects of lower business costs as a result of business use of the internet.
For the future, education and experience will not likely continue to make significant advances. The computer contribution to increases in productivity will probably drop. A consensus forecast is for a declining growth rate in productivity and therefore in real
GDP growth rates.
Growth in
hours worked
Productivity
Real GDP
1950 -73 1973 – 95 1996 – 00 Future
1.6%
2.8%
4.2%
1.7% 1.7% 1.2%
1.4% 2.5% 2.0%
3.0% 4.0% 3.0%
(The numbers do not add in all cases due to rounding and the inclusion of slightly different measures in the productivity and hours calculations. However, increases in the growth in hours worked and increases in productivity will cause similar increases in the growth rates of real GDP.)
Definitions Of Productivity
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It is a challenge to understand all of the different productivity measures. Changes in productivity are calculated for the business sector, the nonfarm business sector, manufacturing (including calculations for durable goods and nondurable goods manufacturing), and even nonfinancial corporations.
The broadest measure is productivity in the business sector, which comprises 77 percent of GDP. The business sector excludes government and nonprofit organizations, employees in private households, and the rental value of owner-occupied housing. The nonfarm business sector excludes all of those activities plus farming and accounts for about 76 percent of GDP. Productivity in the nonfarm business sector is the most commonly used measure in studies of productivity. The reason agriculture is removed is because output and therefore productivity are significantly influenced by weather changes.
Nonfinancial corporate output measures productivity for the nonfarm business sector excluding such activities as banks, securities brokers, insurance carriers, and unincorporated businesses. It accounts for 53 percent of the value of GDP.
Manufacturing includes about 17 percent of business employment. The manufacturing of durable goods includes machinery, computer equipment, electronics, appliances, automobiles and trucks, lumber, furniture, and stone, glass, and cement products (11 percent of employment). Manufacturing of nondurable goods (6 percent of employment) includes food, apparel, paper products, publishing, chemicals, and petroleum products.
The manufacturing data are actually calculated from different sources than the overall statistics and can differ slightly from the other data.
How The Data Are Calculated
Productivity data represent the amount of goods and services (in real terms) produced per hour of labor. They do not identify the separate contributions of labor, capital, and technology. Changes in productivity include the effects of all (except hours of work) possible influences on output – technology, ability, skills, and effort of labor, capacity utilization, managerial skills, and the amount of capital.
Other periodic announcements report multifactor productivity indexes, which do measure the separate effects of hours of labor, education levels and experience of labor, amount of capital, and the effects of technology change.
Importance Of Productivity Changes For Economic Growth
Our capacity to produce goods and services is determined by how much labor we have, how many hours workers work, the workers' skills and intensity of work, the amount of capital workers have with which to work, and changes in technology. Over time, real GDP in the U.S. has increased for all of these reasons. We have a larger population with a larger percentage working. In the last ten years, the average worker has been working longer hours. The workers have significantly larger amounts of capital and new ways of producing and organizing production have been put in place.
The productivity measures capture the effects of the increased capital, the increased experience and education of workers, and the new technology. If productivity increases
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faster than population growth, real GDP per person can increase and we can all enjoy higher standards of living.
The Impact Of Revisions To Productivity Data
The "preliminary" productivity figures are announced slightly more than one month after the end of a quarter. The "revised" productivity figures appear after one more month.
Periodically, additional revisions are made to the productivity data. This last summer revisions were made in the 1999, 2000, and the first quarter 2001 figures. The effects of those revisions were to lower the previously estimated increases in productivity. For example the rate of increase for 1999 was lowered from 2.6 to 2.3 percent and 2000 lowered from an increase of 4.3 percent to an increase of 3.0 percent.
These revisions have received a great deal of press attention - primarily focused on the overestimation of productivity growth. Despite the downward revisions in last two years' productivity growth, productivity was still increasing; the gains were just smaller.
Increases in productivity over the past few years has allowed companies to generate more revenues, leading to higher profits and wages without inflationary pressures. Therefore, although the data may have overstated the increases in productivity, the effects of increases in productivity on the economy were real.
A Classroom Activity On Productivity
Assessing the Effects of Capital, Labor, Technology, and Learning on Output
Economic growth is dependent upon changes in the levels of capital, the labor force, and technology in a country. Increased productivity and technological change will allow for increases in output and increases in wages without affecting the price level. The relationships among factors affecting productivity and output are illustrated in the following activity.
First, divide the classroom into four equal groups and distribute construction paper to each group. Explain that each group is a country and that the paper represents their natural resources. Tell two people in group one that they will have one minute to take their construction paper and tear it into circles the size of a fist. Their goal is to make the most circles in a minute. This may require some quality control to ensure that legitimate circles are being produced. When one minute has elapsed, collect and tally the number of circles. Show examples to the class and ask what should be done to increase the production of circles or the quality of circles.
These circles will probably be very rough around the edges and only approximate a circle. The teacher must make sure that the students are tearing fairly regular shaped circles in order for later sections of this activity to apply. Students may suggest that circle production can be increased by having more students participate, using scissors, or discussing the methods of tearing out circles.
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Suggestions on how to increase the quality of the circles may include using a compass or an object to trace as well as using scissors.
In the second round, distribute two scissors to two people in group 2. Explain that the two students will be given one minute to cut out as many circles (the size of a fist) as they can. When one minute has elapsed, collect and tally the number of circles. Discuss how the output changed with the addition of capital to this economy. Compare examples of the circles made with scissors to those made by tearing and determine if the addition of capital has increased the quality of the product. You may also discuss how you might count the number of rather crude circles in the first round, compared to the larger number of better circles in the second round.
With the addition of capital, more circles should have been produced, each more closely approximating a true circle. When more circles are produced in a given time period with the same amount of labor, this constitutes an increase in productivity of labor. The quality of the circles will have also increased when scissors were used, because now the circles have a more regular shape and do not have ragged edges. Each of the more regular circles perhaps should be counted as more valuable than the rather crude circles. The challenge is to determine how much more valuable. In measuring GDP, we use the market value of the products.
In the third round, have four people in group 3 cut out circles with the same number (2) of scissors. Explain that they will have one minute to cut out as many circles as possible.
When one minute has elapsed, collect and tally the number of circles. Discuss how the gross output changed with a larger labor force. Then divide the number of circles produced by four to determine the productivity.
When the labor force is doubled, more circles should be produced. They may be the same quality as the ones produced with the original labor force. Real output per capita will have increased as the number of circles produced divided by the size of the class will have increased. Determine if the productivity per worker increased. It should be approximately the same or may have decreased. One would expect a decrease in productivity of labor, because of diminishing marginal returns when the amount of capital is held constant. Note that individual workers in the labor force may have different productivity levels and this in turn may have affected the outcome.
Finally, ask the entire class to discuss what other aspects of circle production might be altered in order to increase the number of circles produced or the quality of the circles.
Then select four people (group 4) and have them use whatever resources available to produce their circles. (They may use a compass, trace a coke can, or use other forms of approximating a circle.) When one minute has elapsed, collect and tally the number of circles. Discuss how the output changed with the addition of learning and innovation, and perhaps more capital. Compare examples of the circles made with the new technology and the additional learning, to those made by an increase in labor, to those
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made with scissors, to those made by tearing and determine if this additional information has increased the quality of the product.
By discussing how to approach the task of making circles, the group may come up with more efficient methods of production. For example, one student might trace circles on paper while another student starts cutting circles out. This is specialization of tasks. The main effect here may be on the quality of the product.
Output may fall and productivity may fall, but overall the circles should be of higher quality. Enhanced technology and capital, with labor at a constant, should increase productivity. Ideally, in this scenario, output and quality are the highest. Therefore, this should represent the highest levels of productivity.
Questions
1.
If these groups were four separate countries (one with just labor, one with labor and capital, one with a larger labor force and capital, and one with enhanced technology), which would have the highest productivity rates? Compute productivity and real
GDP per capita (the size of the class) for each scenario.
In order from lowest productivity to highest productivity are: labor (group 1), larger labor force and capital (group 3), labor and capital (group 2), and enhanced technology (group 4). Productivity is measured as output per worker in a given time segment and is the total output divided the number of workers. The real GDP per capita will likely be ranked group 1, group 2, group 3, and group 4.
2.
Compare the circles from the economy with just labor and the economy with labor and capital. Which of the two produced the higher quality circles? Which circles do you value more? How might the quality of some circles be reflected in prices?
The circles from the economy with labor and capital should be of higher quality.
However, productivity may have fallen when the students devoted a little extra time to circle production. Since fewer more accurate circles were produced, these circles may be of higher value and that would be reflected in a higher value for this group. This higher value should be considered in measuring production.
3.
When the labor force increased, did each of the workers have the same productivity rates? What do you think are the effects of higher education on productivity per worker? As an employer, which workers would you hire?
Each of the four students probably produced a different amount of circles.
Higher education levels will increase the skills and therefore productivity of workers. Workers with higher levels of productivity will experience a higher demand for their services in the market, and therefore be able to earn a higher wage rate.
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4.
What were the effects of a classroom discussion on circle production? How is this like trade between countries? Will trade increase productivity in individual countries?
The classroom discussion allowed for a general collaboration of ideas, and the best methods of production were chosen from a number of suggestions. Trade between countries allows for a dispersion of ideas between different areas. When developing countries import products they acquire knowledge of product design and technology and may learn techniques that may increase production and efficiency of their own products.
Additional Questions
1.
Assume that hours worked increase by 1 percent and that GDP increased by 5 percent. Also assume that the GDP implicit price deflator increased by 2 percent.
Calculate the increase in productivity.
2.
Suppose the labor force increases by 1 percent and the hours per worker increase by 1 percent. Also assume that increases in the amount of capital increases output per worker by 2 percent. Prices increase by 3 percent. Increases in education and technology increases output per hour by 1 percent. What are the rates of increase in real GDP and GDP?
3.
An increase in government spending on research and development may enhance abilities to produce goods and in effect increase productivity. Is such spending wise?
4. Why is productivity rising when the economy is slowing down?
Sample Answers For Additional Questions
1.
Real output increased by 3 percent (5% – 2% = 3%). Productivity is output per hour worked. Thus the increase in productivity is 3 percent minus the change in the number of hours (one percent). Productivity increases by 2 percent.
2.
Labor inputs increase by 2 percent. Output per hour increases by the contribution of capital, education, and technology - 3 percent. Real GDP will thus increase by 5 percent. Given an inflation rate of 3 percent, nominal GDP will increase by 8 percent.
3.
Obviously such spending has benefits. Production should increase and we will be better off as a result of the increased spending. However, economic analysis would tell us that there are opportunity costs. If other productivity enhancing activities are given up as a result of the increase in government spending, it is less clear that such spending is wise.
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4.
Spending is declining and businesses are adjusting output downward. In the process of doing so, businesses are reducing the number of hours and employees by more than the reduction in output. Thus, measured productivity increases.
Relevant National Economic Standards
The relevant national economic standards are numbers 13, 15, 18, and 20.
13. Income for most people is determined by the market value of the productive resources they sell. What workers earn depends, primarily, on the market value of what they produce and how productive they are. Students will be able to use this knowledge to predict future earnings based on their career plans for education, training, and career options.
15. Investment in factories, machinery, new technology and in the health, education, and training of people can raise future standards of living. Students will be able to use this knowledge to predict the consequences of investment decisions made by individuals, businesses, and governments.
18. A nation's overall levels of income, employment, and prices are determined by the interaction of spending and production decisions made by all households, firms, government agencies, and others in the economy. Students will be able to use this knowledge to interpret media reports about current economic conditions and explain how these conditions can influence decisions made by consumers, producers, and government policy makers.
20. Federal government budgetary policy and the Federal Reserve System's monetary policy influence the overall levels of employment, output, and prices. Students will be able to use this knowledge to anticipate the impact of federal government and Federal
Reserve System macroeconomic policy decisions on themselves and others.
Sources Of Additional Activities
Advanced Placement Economics: Macroeconomics. (National Council on
Economic Education)
Unit 1: The Basic Economic Problem
Focus on Economics: High School Economics (National Council on Economic
Education)
Lesson 9. Getting More or Using Less
Lesson 17. The Circular Flow of Economic Activity
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Capstone: The Nation’s High School Economics Course
Unit 1: 9. The Circular Flow of Economic Activity
Unit 3: 6. Productivity
Unit 6: 2. Making a Macro Model: Consumers
Unit 6: 3. Making a Macro Model: Investment
Handbook of Economic Lessons (California Council on Economic Education)
Lesson 20: Plotting the Ups and Downs of the U.S. Economy
Lesson 21: The Fluctuating Economy: A Look at Business Cycles
Lesson 23: Economic Growth
All are available in Virtual Economics, An Interactive Center for Economic Education
(National Council on Economic Education) or directly through the National Council on
Economic Education.
Authors: Stephen Buckles
Erin Kiehna
Vanderbilt University
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