Productivity Growth, Who Needs It?

As I look at the revision of Productivity and Costs, First Quarter 2009, I see some good and bad in the numbers.  The good is that the overall manufacturing productivity was revised to -2.7 percent from an initial -3.4 percent.  All of that gain, and more, is due to a change in the nondurable good manufacturing from an initial -0.01 percent to the revise increase of +1.9 percent.  The bad news is that the manufacturing productivity of durable goods, went from -10.0 percent to -10.4 percent.  Overall though, I am not worried about the drop in productivity.

I am not worried about the lost productivity for two reasons.  First, productivity always drops during a recession.  Second, the steep drop means employers are keeping on more employees then they need to manufacture their goods.  Productivity will quickly recover once the economy starts to expand again and production starts to pick up.  The retaining of workers is indicative of employers continuing their research and development, and other future benefit activities, even though they are producing less. 

The recent May 2009 Manufacturing ISM Report On Business had two significant improvements: An above 50, or expanding, index reading in New Orders and a much improved index score in Backlog of Orders.  With a 51.1 index, the New Orders reading is a nice positive, but it is only part of the story.  The real important number is the 7.5 improvement in the Backlog of Orders from 40.5 to 48.  This is a significant change in the rate that the manufacturer’s backlog of orders is shrinking.   

It is critical that companies continue to work on the next generation of, or a better way to manufacture their product.  Not all companies can just shed costs, like GM did with the UAW, to improve their cost competitiveness.  Improvements in productivity are what allow manufacturers to keep product costs down while increasing employee compensation. 

Most economists agree that there will not be a significant increase in demand anytime soon.  In addition, companies will not ramp up production until they see that their orders backlog is increasing for a little while.  Backlogs have been decreasing for 13 months, so manufacturers will want to get a little backlog cushion before they do any significant increase in production.  This leave productivity as the mechanism for maintaining profits.  

Once production starts to ramp up we will see productivity shoot up.  On one hand this is a good thing because it makes American manufacturers more competitive.  On the other hand, higher productivity means it takes less to do more.  In a Clemson University study authored by William Ward, it was argued that due to productivity improvements alone roughly 42.4 percent of the manufacturing jobs that existed in 1990 would have no longer be needed in 2004.

Productivity numbers are funny.  A drop in productivity means a loss of competitiveness due to higher unit costs, a bad thing.  A large drop in productivity late in a recession can be seen as an indicator of business investment in future productivity gains, which is a good thing.  An increase in productivity makes a company more competitive, a good thing.  If a company’s productivity increase is greater than the company’s gain in market share and market expansion then job losses are inevitable.  This is a bad thing for the overall economy.

In the end, judging productivity numbers is a hard thing to do accurately.  I guess an old saying is good way to look at them.  Nothing is as good as it looks or as bad as it seems.