The U.S. economy took a couple more steps toward landing softly this week. First, labour demand continued to moderate. Though still high at above nine million, job openings retreated for the fifth time in six months in June, while growth in nonfarm payrolls slowed to 187,000 in July from an average of 270,000 in the first half of the year. Second, and perhaps most importantly, workers are becoming more productive, helping to offset their rising cost.
Labour productivity for nonfarm businesses jumped 3.7% annualized in the second quarter. Productivity in the manufacturing sector, which has been sagging for the better part of a decade, snapped back sharply. The improved efficiency offset a good chunk of a 5.5% spike in hourly compensation to hold unit labour costs (ULC) to a modest 1.6% advance, or half the prior quarter’s pace. On a year-over-year basis, growth in productivity now matches the 5-year norm of 1.3% prior to the pandemic. Though not historically strong (productivity growth has averaged 2.1% since 1948), the improvement partly countered a 3.7% rise in hourly compensation (moderating but above the 3.0% norm in the 5 years before the pandemic), leading to calmerULC growth of 2.4%. While this rate is still above the pre-pandemic mean (1.7%), it’s approaching the 2% level that would be consistent with the inflation target. This means that just a modest further improvement in productivity and/or moderation in compensation might be all that’s needed to restore price stability.
Soft landings are rare historically because they require two things that tend to oppose each other: resilient growth and declining inflation. Worker hoarding is adding durability to the expansion, as consumers are unlikely to slash spending if they have a job. And, now, better productivity promises to depress ULC and inflation further. So far, steadier resource prices and smoother-running supply chains have played a key role in reversing inflation’s climb to four-decade highs. To achieve further progress in what could be a sticky last-mile solution, ULC growth will likely need to moderate somewhat further on a sustained basis. It’s no coincidence that in the past 63 years, median annual growth in ULC and core PCE prices has averaged a similar 2.3%. In the past quarter century, the median for both was 1.7%, modestly below the inflation target. Where ULC goes, inflation tends to follow with a one quarter lag.
There are several reasons why productivity could be turning up. First, more companies are using new technology (notably AI) to cut costs and meet demand in the face of worker shortages. Second, with supply chains running smoother, workers are spending less time troubleshooting and waiting around for parts and materials toarrive, and more time adding value. Third, workers are quitting less than in the past two years, and the lower churn means less time is spent training to bring them up to peak efficiency.
There’s no guarantee that productivity will improve further. But if it does, it will provide the best chance for the Fed to achieve a soft landing, and the least painful outcome for workers and the economy.