Saturday, January 28, 2017

It's "Productivity and Cost", not "Productivity and Labor Cost"


Last week I suggested that we can improve productivity by reducing costs: in particular, by reducing the cost of finance.

Usually I try to avoid making claims like that, because I don't see cost in the calculation of productivity. Productivity is output per hour of labor. The units for "hours of labor" are time. The units for "output" are ... output, I guess. Things. Stuff. There is no cost number in the "things produced per hour" calculation. So until now I have tried to avoid talking about the connection between productivity and cost.

Of course, I have pointed out the increase in productivity that arose in the 1990s, just after Household Debt Service (a financial cost) went low:

Graph #1: Debt Service (blue) and Labor Productivity (red), and Forecast
(The graph also shows that I expect productivity to rise again soon.)

And I have pointed out that productivity always goes high as we're coming out of recession:

Graph #2: Productivity (Percent Change from Year Ago)
Recessions are times when costs are reduced. High productivity follows, every time.

And I have pointed out that productivity reliably goes high after financial costs go low: for two decades after the Second World War, and again for most of a decade after 1995. When productivity goes high again, over the next few years, it will confirm my hypothesis (though Donald Trump may get all the credit).

Even though the relation between productivity and financial cost is right there on the graphs, I have always avoided talking about the connection between productivity and cost because there is no cost number in the "things produced per hour" calculation.

That's about to change. I noticed that FRED lists productivity and costs together. And BLS puts productivity and costs together. And I thought about it.

Labor is not the only cost of doing business. It is generally the biggest, but not the only cost. If nothing else changes, a change in business financial costs will certainly affect business costs. Likewise, a change in household financial costs will affect consumer spending, and the resulting change in demand will affect business activity, output produced, labor hours consumed, and productivity.

Cost influences productivity, even though cost is not in the productivity calculation.

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