Initially, the number released for economic activity in the first quarter of this year did not make sense. Total employment increased by nearly 1.7 million workers, yet total output declined. How is that possible?
It is possible because, after the productivity numbers were released, it was revealed that newly hired workers not only didn’t add any output, they actually caused output to decline.
Historically, when the economy is growing at an annual rate of 2% to 3%, about 200,000 jobs are added each month. Last year the economy grew at a 5.7% rate, and the economy added more than 500,000 jobs per month.
In January, February and March of this year, almost 600,000 jobs were added monthly. Most economists expected a 3% growth rate for those months. Economists were shocked when the reported growth was negative. The Commerce Department reported the annual growth rate for the quarter was -1.4%.
Adding that many jobs with total output declining simply did not make sense, at least not until the productivity number was released. Productivity decreased by 7 1/2%. Now the numbers do make sense, but the interpretation is very disturbing.
Productivity is a measure of the increase in output from the same amount of input.
In other words, suppose there are 100 workers that produce 100 units of output per day. After the workers have been doing their job for a year, they start to figure out ways to increase output by becoming more efficient. So next year, the same 100 people produce 103 units per day.
That means productivity increased by 3%. Workers are then entitled to a 3% wage increase, since a worker is paid according to the contribution made. If workers produce 3% more output, they should receive a 3% increase in wages. Labor costs for the firm stay constant.
Using my example, what happened in the first quarter is that instead of 100 workers, there were 101. They not only did not increase output, but they produced only 92 ½ units, raising the cost to produce each unit.
Assuming the new hires in the first quarter were paid about the same as other workers, the 1.7 million workers increased total employment cost by just over 1%. Considering the 7 1/2% decrease in productivity, total labor costs for the firm, increased by 9%, before considering the 5.5% wage increase the average worker received. That will lead to higher inflation in the near future.
Looking beyond the numbers, the interpretation is that the newly hired workers not only contributed nothing to total output, but actually caused other workers to be less efficient resulting in less output. This is very disturbing, especially considering how that could have happened.
One possible explanation is that firms are having so much trouble hiring qualified workers that they have been forced to hire completely unqualified workers. Those workers must be trained and it appears that the training of those workers reduces total output.
Perhaps instead of pushing for higher minimum wages and higher overall wages, the focus should be placed on increasing worker efficiency. When workers become more productive, higher wages will gladly be offered by the firms. The problem we will face this year is that the declining productivity means workers are less valuable. Firms will have a difficult time agreeing to wage increases for workers who are producing less.
At the same time, workers this year will demand wage increases of 10% or more. They will argue that they need a 10% raise this year. That’s because, with the 8 ½% inflation rate, a 10% raise will just keep them slightly above the increased cost of living.
The problem is that with declining productivity coupled with a 10% increase in wages, labor cost will increase by far more than 10%. Couple that with rising energy costs and rising raw material costs, the total cost to produce will rise significantly. In order to maintain profit margins, firms will have to raise their prices, meaning there is higher inflation expected this year.
Labor’s argument that they “need” higher wages, is really not valid. In communism, a person is paid according to their need. In capitalism, a worker is paid according to the contribution. Since the declining productivity means workers are contributing less, no increase in wages is due.
If workers don’t start increasing their productivity, inflation will get much worse. The higher prices will eventually cause consumers to buy less goods and services, which leads to a recession. That’s one of the reasons economists are starting to forecast a recession, perhaps as soon as the end of this year.
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