Labor Cost Per Unit of Output

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The following is excerpted from a news release by the Bureau of Labor Statistics called “Productivity and Costs”. It was released on March 6, 2007. This excerpt describes recent trends in real worker compensation and unit labor costs for the manufacturing sector:

“Manufacturing productivity increased 2.2 percent in the fourth quarter of 2006, as output decreased 2.1 percent and hours fell 4.2 percent (seasonally adjusted annual rates). The productivity increase was the smallest since the first quarter of 2004, when output per hour declined 1.7 percent. In durable goods industries, productivity increased 3.4 percent as both output and hours decreased, 0.9 percent and 4.2 percent, respectively. In nondurable goods industries, output per hour rose 0.8 percent, reflecting decreases of 3.5 percent in output and 4.2 percent in hours. In the third quarter of 2006, productivity increased 5.9 percent in total manufacturing, 8.1 percent in durable goods industries, and 2.7 percent in nondurable goods industries.

“Manufacturing hourly compensation grew at a 7.1 percent annual rate during the fourth quarter of 2006. Durable and nondurable goods manufacturing posted increases in hourly compensation of 7.4 percent and 6.4 percent, respectively. Consumer prices decreased slightly in the fourth quarter of 2006, contributing to real hourly compensation gains of 9.3 percent in total manufacturing, 9.7 percent in durable manufacturing, and 8.7 percent in nondurables.

“Unit labor costs in manufacturing increased 4.7 percent in the fourth quarter of 2006 after falling 5.8 percent in the third quarter. These costs increased 3.9 percent in durable goods industries and 5.6 percent in nondurable goods industries during the fourth quarter of 2006.”

http://www.bls.gov/news.release/prod2.nr0.htm

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The following perspective is excerpted fro a speech given by Federal Reserve Governor Randall S. Kroszner to the Forecaster’s club of New York in New York City on September 27, 2006. In it he discusses labor costs as a primary factor in productivity and final prices for goods:

“If we lived in a world with no impediments to competition in labor and product markets, with prices and wages that freely and quickly moved up and down in response to shifts in economic conditions, then a change in productivity growth would be promptly matched by a corresponding change in nominal compensation per hour. As a consequence, unit labor costs would be unchanged, and all else equal, so would inflation.

But, we don’t live in such a perfectly competitive, frictionless world. Nominal compensation per hour initially seems to respond sluggishly to changes in the economy, including productivity shocks. As a result, an increase in productivity growth, for example, initially slows the growth of unit labor costs, which firms--under competitive pressure--then pass on to their customers, thereby slowing price inflation. As price inflation slows and as, with a lag, nominal compensation per hour accelerates, the growth rate of real compensation per hour increases so that over time workers share in the benefits of faster productivity growth. Indeed, in the past, any rise in the level of productivity has eventually been fully translated into a rise in the level of real compensation per hour. How quickly the re-equilibration takes place depends in part on the extent of competition in product markets and the nature of the wage-bargaining process. Up until now, the process in our economy has taken at least a few years, but it has always occurred.

What I have dubbed the re-equilibration of productivity and real compensation per hour is just another manifestation of one of the great stylized facts of macroeconomics: In the past, deviations in the labor share of income from its mean value of roughly two-thirds have eventually been reversed. But the two-thirds share is an empirical observation about the U.S. economy; it is not an immutable number derived from the first principles of economic theory. As it turns out—I’ll leave the proof to you as a homework assignment—mean reversion in the labor share is equivalent to the observation that over time labor productivity and real compensation per hour have moved together; in the jargon of econometrics, they are co-integrated.

As I just mentioned, when the labor share deviates from its long-run average or, equivalently, a gap opens between productivity and real compensation per hour, the reversion to the mean (that is, the closing of the gap) can take quite a while. In recent years, the labor share has moved down as increases in real compensation per hour have, for the most part, lagged behind productivity growth, but the timing and extent of the change in the labor share depends in part on the particular statistical measure chosen.”

http://www.federalreserve.gov/boarddocs/speeches/2006/20060927/default.htm

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The following is excerpted from the Frequently Asked Questions page of the Bureau of Labor Statistics webpage. In it methodology for determining measures for output is discussed as well as the effect of outsourcing on productivity and output per hour:

"How are changes in output measured for specific industries?

Different products are aggregated into one output measure by weighting (multiplying) the relative change in the output of each product by its share in the total value of output. Thus, the products that require more resources to produce are given higher weight. For tangible products such as tons of steel, developing an output index series and ultimately a productivity series seems not to be too difficult. How are measures developed for those industries where data on quantities produced are not available? How do you, for example, measure the output of barbershops?

If data were available on the number of haircuts, shaves, etc. performed, these data could be used just as we would have used data for tons of steel. We might weight haircuts and shaves differentially, but the concept is the same.

Generally, data for the quantities of output produced or the number of times a service has been performed are not available. However, an alternate methodology is available. Barbershops may not know how many haircuts, etc. have been performed, however, they will know how much revenue they have received from these services. Changes in revenues reflect changes in both quantity of output and its price. Price changes are removed by dividing an index of revenue by a price index, the remainder being an index of quantity. Does outsourcing and offshoring of intermediate production inflate the productivity measures?

In the business sector, outsourcing to domestic nonmanufacturing industries and offshoring to foreign businesses alter the distribution of production among firms. Since firms can differ in their productivity, domestic outsourcing can affect business sector productivity if the contracting firm differs in its productivity from the outsourced production. Similarly, offshoring can affect business sector productivity if the productivity of the production lost to offshoring differs from the productivity of remaining and any new U.S. business sector production. Any effect of offshoring on business sector productivity change is expected to be modest.

Outsourcing and offshoring have the potential for greater effect on labor productivity at the industry level. In manufacturing, outsourcing and offshoring have contributed about 1.5% per year to sectoral output per hour growth between 1973 and 1995. Their contribution has slowed to only about 1% per year thereafter and as a result they do not appear to be an explanation for the productivity speed-up in manufacturing."

http://www.bls.gov/lpc/faqs.htm

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The following perspective is excerpted from a speech given by Federal Reserve Governor Ben S. Bernanke at the meetings of the American Economic Association in San Diego, CA on January 4, 2004. In it he discusses how unit labor costs affect the costs of production and therefore final prices for consumers:

"Labor costs account for the lion's share, about two-thirds, of the cost of producing goods and services. The labor cost of producing a unit of output depends, first, on the dollar cost per hour (including wages and benefits) of employing a worker and, second, on the quantity of output that each worker produces per hour. When the cost per hour of employing a worker rises more quickly than the worker's hourly productivity--the historically normal situation--then the dollar labor cost of producing each unit of output, the so-called unit labor cost, tends to rise. Recently, however, labor productivity has grown even more quickly than the costs of employing workers, with the result that unit labor costs have declined in each of the past three years. Indeed, in the second and third quarters of 2003, unit labor costs in the nonfarm business sector are currently estimated to have declined by a remarkable 3.2 and 5.8 percent, respectively, at annual rates. Again, because labor costs are such a large part of overall costs, and because capital costs have also been moderate, the business sector has enjoyed a net decline in total production costs."

http://www.federalreserve.gov/boarddocs/speeches/2004/20040104/default.htm

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