Michelle ThompsonAmericans are on the brink of experiencing a significant economic milestone: the normalization of inflation, even after a series of aggressive interest rate hikes, without plunging into a recession. This situation, often termed a “soft landing” by analysts, marks a historic event.
The notable progress observed can be attributed in part to a recent surge in productivity growth. Strong productivity in the United States last year allowed workers to enjoy substantial wage increases without employers needing to significantly raise prices for consumers. This was because workers were generating enough output across various industries and services to offset the higher labor costs.
In economic terms, productivity refers to the efficiency of producing goods and services, essentially getting more done with less. With productivity showing strength last year, the economy managed to maintain robust growth in 2023 without fueling inflation.
Productivity is quantified by dividing the total output of goods and services by the total hours worked. According to data from the Labor Department, this rate surged by 2.7% in the fourth quarter compared to the previous year, surpassing the average increase over the past two decades. After a sharp decline in 2022, productivity rebounded significantly in the following year.
Lauren Goodwin, economist and chief market strategist at New York Life Investments, emphasized the crucial role of productivity in shaping the broader economic and inflation outlook. Central banks are closely monitoring whether workers will continue to enhance productivity, as it holds significance for economic stability.
What factors have contributed to the increase in productivity?
There isn’t a single definitive explanation for the significant growth in productivity observed last year.
One prevalent theory suggests that the widespread adoption of generative artificial intelligence (GenAI) may have contributed to efficiency improvements in certain tasks. Researchers suggest that GenAI could have transformative effects not only in finance and economics but also in broader society, reminiscent of the widespread internet adoption in the early 2000s.
However, realizing substantial productivity gains from GenAI might take time, as workers require training on its usage, and companies need to determine the most effective ways to integrate GenAI into their operations, as noted by Mark Zandi, Chief Economist at Moody’s Analytics.
Another possibility is that companies boosted productivity in anticipation of a recession that ultimately didn’t materialize, according to economists. Despite a robust job market, some major corporations still implemented cost-cutting measures, including layoffs by companies like Microsoft, Meta, 3M, and Citigroup. John Min, Chief Economist at Monex USA, explained that these layoffs left companies more streamlined, which, coupled with a thriving economy, resulted in higher productivity, supporting wage growth and mitigating inflationary pressures.
It’s plausible that last year’s productivity surge stemmed from a combination of these factors.
The issue with the data lies in its reliability and accuracy.
Federal Reserve officials evidently take productivity into account when formulating policy decisions. Austan Goolsbee, President of the Chicago Fed, emphasized the significance of understanding productivity trends before drawing conclusions about wages.
However, accurately measuring productivity in real-time poses challenges, leading to limited market impact upon its release. Additionally, given its quarterly release schedule, productivity data are often subject to substantial revisions, especially in the context of service-based industries where measurement is inherently complex.
John Min noted the difficulty in precisely assessing service-based productivity, contrasting it with the relatively straightforward measurement of manufacturing productivity based on units produced per hour.
Reflecting on the productivity surge in 2023, there’s speculation about its role in paving the way for a soft economic landing. Despite this, it remains uncertain whether this surge represents a lasting transformation in the US economy.
Lauren Goodwin cautioned that productivity spikes at the end of economic cycles may result from cost-cutting measures rather than genuine efficiency gains. She highlighted the importance of considering broader economic trends, particularly concerning labor practices.
Nevertheless, Goodwin expressed optimism about the potential long-term impact of generative tools on productivity, foreseeing gradual disinflation as a result.
