The power and puzzle of productivity

This week, all eyes will be on Federal Reserve policymakers and their decision to cut, raise, or stand pat on interest rates. But there’s another data point that could have an even greater impact on the economic and inflation outlook for 2025: productivity. 

On May 8, the Bureau of Labor Statistics will deliver new data on productivity, which is defined as worker output per hour. In the fourth quarter of 2024, worker output increased 2.4 percent from the prior quarter while hours worked to produce that output rose only 0.8 percent.  

Year-over-year, productivity was up 2 percent in the fourth quarter. For the full year, productivity rose 2.7 percent.    

Apart from the pandemic-driven productivity spike of 2020, 2024 delivered the highest average productivity rate in 15 years. 

Strong productivity delivers a host of benefits: faster economic growth, lower inflation, higher pay for workers, and greater profits for businesses.  

Productivity puzzles 

If 2025 productivity can maintain its 2024 strength, it would be a turning point for the U.S. economy. For more than a decade, the economy has been marked by lackluster productivity.  Between 1989 and 2010, productivity averaged 2.4 percent a year.  Since 2011, that annual average has fallen by a full percentage point, to 1.4 percent. 

This recent slowdown has puzzled economists for two reasons. First, one key driver of productivity, spending on research and development, has been soaring.  From 1989 to 2010, research and development spending grew an average of 2.8 percent a year.  Since 2011, it’s grown by an average of 4.4 percent a year.  

If the economy is spending more on research and development, why hasn’t innovation boosted productivity growth? 

Productivity in manufacturing is a second mystery. From 1989 to 2010, manufacturing led U.S. productivity, with 3.7 percent average annual productivity growth. But since 2011, productivity in manufacturing has contracted to an annual average of 0.3 percent.  

Manufacturing historically has been one of the most innovative parts of the economy. Yet for more than a decade, a chasm has opened between the development of new manufacturing technologies and output by manufacturing workers. 

 
Productivity and pay 

Another way to look at productivity is how much businesses pay workers to produce a unit of labor. In 2024, year-over-year worker pay grew by 4.1 percent, in line with historical trends.  

This is where the math gets interesting.  

If wages are growing at about the same rate as before, but productivity has fallen, the cost to produce a single unit of something will rise. And that’s exactly what’s happening.  

Between 1989 and 2010, unit labor costs rose by an average of 1.5 percent a year, a rate consistent with the less-than 2 percent inflation we saw during those decades. 

Since 2011, per-unit labor costs have risen by 2 percent a year on average. And even though 2024 put up strong productivity growth relative to its recent 15-year average, unit costs are still growing faster than they were.  

My take 

Turning points in the economy are notoriously hard to predict. But an economy that can withstand the uncertainty of inflation, tariffs, and consumer spending fatigue is one that can point to its strength in productivity.  

The week ahead 

Wednesday: The big news of the week might not be all that newsworthy. The consensus of economists is that Federal Reserve policymakers will leave interest rates at current levels when they meet May 6 and 7. 

Thursday: In addition to an update on business-sector labor productivity, we’ll get data on weekly initial jobless claims, a proxy for layoffs. Last week we saw a crack in the armor of the labor market when initial claims increased to 241,000 from the 226,00 average over the previous four weeks. And a rise in continuing claims showed that it’s taking longer for people to find work. Claims data and productivity numbers will be important clues as economists try to gauge how the economy will evolve in coming months.