Productivity makes everything better. That’s because, in simplest terms, it means getting more bang for your buck—doing more, with less, if you will.
Regarding the economy, I like to think of productivity as a chef sharpening a knife. Just as a sharp knife allows a chef to cut ingredients more quickly and precisely, boosting productivity enables an economy to produce goods and services more efficiently, leading to higher output and economic growth.
In other words, productivity measures how efficiently businesses are producing stuff with their available workers. To calculate productivity, we subtract hours worked from total output to get the output per hour of all workers. This is the key metric shown on the bottom clip of our indicator above.
Specifically, it shows the year-over-year growth rate of productivity. As you can see, it fell to record low levels last year but has jumped significantly in recent months, to 2.6% currently.
Why is this such an important development right now? Well, because the other great thing about productivity is that it allows an economy to grow without inflation. The more productive workers become, the more firms are willing to pay them higher wages without increasing overall prices and sacrificing profit margins. This is known as “real wage growth,” and it helps keep overall inflation down.
Sure enough, if we look at the top clip of our indicator, we can see that when the year-over-year change in productivity is above at least -0.2%, the average annualized gain for the Consumer Price Index (CPI)—a broad measure of inflation—has been about 3.5%, versus a 6.4% gain when productivity has been below -0.2%. Inflation has been a real problem for the past few years, so the recent surge in productivity is an encouraging sign that perhaps it has finally been tamed.
But, of course, there’s always a risk that the recent gains in productivity are short-lived. We had a surge in productivity in the mid-1970s, which helped bring headline inflation down. But then productivity dipped back into negative territory, and we got another dose of sky-high inflation going into the 1980s.
The bottom line? The recent surge in productivity has been a boon for the overall economy and its workers, and it will help keep a lid on inflation if it persists. However, investors should proceed cautiously until we can be sure that the recent productivity gains are sustainable—and that inflation is truly under control.