When I was employed in Manufacturing at what was once America's largest printed circuit board manufacturer, Photocircuits Corp., I had the opportunity to work as a supervisor in the back end operations and do some industrial engineering.
Facing fierce price competition from China, we were drastically challenged to find ways to economize our operations.
Basically, we needed to figure out how to do more work with the same amount of aggregate hours or do the same amount of work with less aggregate hours.
Improvements in productivity have been pretty much a constant in U.S. industry. Engineers have continued to find ways of doing more work with the same number of hours or the same level of work using less hours.
Ultimately, we want higher and higher productivity. To use an extreme, in the beginning of civilization, most people were employed either making clothes or growing and gathering food. Declining productivity would put civilization back in that direction.
Japan's demographics and productivity growth make for a great example of how productivity growth kept their economy from declining while their aggregate hours worked collapsed from 1990.
Here is a chart of Japan's aggregate hours worked from 1970 - 2011. This is based on the total civilian employment X average annual hours worked per employed person:
One reason for the decline in aggregate hours worked is the percent of the population that was employed has been dropping:
The other reason is the average annual hours worked per employed person had dropped steadily since 1990:
Now here is Japan's Real GDP in U.S. dollars:
Despite the drop in aggregate hours worked, Japan increased their overall economy since 1990. GDP, on a per capita basis also increased in similar fashion:
The reason for this is the industrial engineers economizing operations.
Here is a chart of output per hour in Manufacturing in Japan:
In essence, productivity growth saved Japan's economy, from a standpoint of real GDP per capita, from collapsing along with aggregate hours worked.
The Conference Board, a global economic research institute, provides this chart in their annual productivity brief.
In developed economies, a good deal, if not all of the low hanging "productivity improving fruit" has been picked. The year over year percent change of labor productivity has been declining since around 1990 in mature economies.
The U.S. is in a slowing growth period based on labor demographic trends. The labor force participation rate is declining steadily and consistently:
The employment to population ratio is stuck in the mid 58% range since the recession ended in mid-2009:
U.S. labor demographic trends are not very promising. While there is great potential to increase total aggregate hours worked, if we continue to revert back to labor participation rates of the 1950s and 1960s, we have a ways to go.
This is why productivity is important for real GDP per capita growth in the event we see another drop-off in the percent of the population employed and aggregate hours worked declines.
With the collapse in public construction spending and overall gross capital formation in the U.S., it's difficult to get optimistic about future productivity growth as investments in infrastructure and new tools play a big role in helping us become more productive.
So far in 2013, year over year percent change in output per hour in the nonfarm business sector is very low, coming in at 0.0% in Q1 and 0.3% in Q2.
Taking a step back, the 10 year rate of change in the nonfarm business sector output per hour worked looks like this:
Similar to labor demographics, the trend is down.
Real disposable income per capita should go nowhere in this environment. That has been the trend since about 2006, per this chart below:
What I am watching for is economic growth in real terms to remain subdued at best but even decline in the coming 3-5 years due to lack of gross capital formation, higher tax burdens, poor labor demographic trends and most important, poor rates of productivity growth.
Investors' best defense is first and foremost, shore up one's own home economy by owning the most efficient and durable tools to alleviate future investment needs. Nothing will beat owning a product or tool that is durable enough to last the rest of your life but second to that, owning durable products with a high life cycle.
Outside of really good stockpicking, investors need to have low expectations for fixed income and aggregate stock index investing in a low productivity growth environment.