US labor productivity falls, costs rise in Q1 2023.

Labor Productivity Falls and Labor Costs Rise, Posing a Challenge to the Federal Reserve

Decline in Labor Productivity

The first quarter of 2023 saw a decline in labor productivity, while labor costs rose, posing a challenge to the Federal Reserve as it raises interest rates to control persistent, decades-high inflation. According to a May 4 press release by the U.S. Bureau of Labor Statistics (BLS), nonfarm business sector labor productivity, which measures the hourly output per worker, declined by 2.7 percent in the first quarter of 2023 compared to the previous quarter. Productivity fell by 0.9 percent compared to a year back, which is the fifth straight quarter that productivity fell on a year-over-year basis. This is the longest stretch of such declines since the series began in 1948.

Rise in Labor Costs

The BLS report also stated that unit labor costs in the nonfarm business sector increased by 6.3 percent in the first quarter of 2023, reflecting a 3.4 percent increase in hourly compensation and a 2.7 percent decrease in productivity. Unit labor costs increased by 5.8 percent over the last four quarters. In the manufacturing sector, labor productivity fell by 1.3 percent in the first quarter of 2023, while unit labor costs rose by 3.4 percent during this period.

Impact on the Federal Reserve

The Federal Reserve raised its benchmark interest rate by another 25 basis points on Wednesday, pushing it into a range of 5.0–5.25 percent. Since March 2022, the Fed has raised interest rates by 500 basis points. However, higher labor costs are likely to encourage the Federal Reserve to continue with its policy of hiking interest rates. Faster wage gains pose a problem for the Fed, as rising wages can keep pushing up prices, making it hard for inflation to get back to the Fed’s target rate of 2 percent. Annual inflation has remained at or above 5 percent for every single month since May 2021 through March 2023.

Low Productivity Rate

The May 4 BLS report notes that while the manufacturing sector output and hours worked both grew at an annual rate of 0.3 percent since the fourth quarter of 2019, labor productivity has had “no growth since the start of the business cycle.” This is a historically low productivity growth rate and matches the 0.0 percent annual rate of the last business cycle from the fourth quarter of 2007 through the fourth quarter of 2019.

Job Losses

While labor productivity dips and the Fed continues to push up rates, job losses are accelerating. According to a May 4 report by Challenger, Gray, & Christmas, U.S.-based employers announced 66,995 job cuts in April 2023, which is a 176 percent increase from April 2022. This is the fourth consecutive month this year that job cuts were higher than the corresponding month a year earlier. In the first four months of 2023, employers have already announced 337,411 layoffs, which is up 332 percent from the same period last year.

Impact of U.S. Debt Ceiling

More job losses might be coming in case the U.S. debt ceiling is breached, according to a May 3 report by the White House Council of Economic Advisors. Treasury Secretary Janet Yellen has already warned that the United States could default on its financial obligations as early as June 1. According to the report’s worst-case scenario, which involves the United States failing to raise its borrowing levels for over three months, around 8.3 million jobs could end up being wiped out, with the unemployment rate rising to 5 percent.