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By Dirk van Dijk

The nation's productivity, or output per hour worked, increased at a seasonally adjusted annual rate of 6.9% in the fourth quarter. That is up substantially from the preliminary estimate of a 6.2% increase.

The 6.9% is a slowdown from the 7.8% rate in the third quarter and the 7.6% rate in the second, but is still extremely impressive. Actually, all the more impressive coming on top of the previous gains. Meanwhile, unit labor costs, or how much it costs a business in wages and fringe benefits to produce a unit of output, dropped at an annual rate of 5.9%, a far bigger decline than the 4.4% original estimate and much more than the 4.5% expectation.

As the first graph below shows, both numbers tend to be extremely volatile from quarter to quarter and will move in opposite directions. Usually productivity will deteriorate as we head into a recession and in the early stages of one, but then rebound later in the recession and coming out of one.

The second graph smoothes out the spaghetti a bit by showing the same data on a year-over-year basis. On a year-over-year basis, the 5.8% rate is the highest since the first quarter of 2002, and has only been exceeded one other time since 1967 -- a 5.9% rise in the first quarter of 1973.

Year-over-year unit labor costs are at a record low. This goes a long way towards explaining why we have seen such excellent earnings in recent quarters while the economy has been in such a deep slump and with unemployment near double-digit levels (and underemployment in the high teens).

Productivity & Standard of Living

Over the short term, the rise in productivity is mostly a reflection of fewer hours worked, rather than a robust rise in output. However, over the long term, there is nothing more important than productivity. It is what determines the standard of living in a country, not GDP.

After all, even under Mao, mainland China had a higher GDP than Sweden had, but the standard of living of a person living in Sweden was vastly higher than that of someone living in China at the time. Put another way, the principal difference between an American truck driver and a Chinese coolie is the truck. Both transport goods, but the U.S. truck driver is far more productive (tons moved per hour) because he has the tool, a big truck made by Paccar (NASDAQ:PCAR). As a result he is able to have a higher standard of living.

In the short term, though, if a new truck design (say, pulling two trailers instead of just one) means that one truck driver is now out of work, his standard of living will go down, and the other driver (the one pulling two trailers) might go up a little bit. The trucking company, though, reaps a huge benefit, having to pay only one driver to move two trailers. Hence its unit labor costs go down. Higher productivity is both the enemy of employment (short term) and the powerful ally of higher standards of living (longer term).

Manufacturing & Productivity Gains

Nowhere is this dynamic more apparent than in manufacturing. The manufacturing sector has been losing jobs in good times and bad for the last 30 years or so, yet total manufacturing output in the country has continued to grow.

The third graph shows that productivity growth in manufacturing is much more volatile than overall productivity growth, but has generally been far higher than in the rest of the economy. The data for manufacturing productivity alone does not go back nearly as far, however, but that allows for a clearer picture of more recent overall productivity trends in that graph.

Factory automation has probably caused more jobs to be lost than outsourcing to third-world countries. However, we don’t want to cure the unemployment problem by reversing productivity gains.

Think about it this way: back in the 1950’s most telephone calls were completed by actual physical operators (think Lily Tomlin: "one ringy dingy, two ringy dingy"). We could immediately solve the unemployment problem tomorrow, and have massive labor shortages, if we simply outlawed the computerized switching of phone calls and had to have calls completed by actual human operators. Of course, that would mean that we would be back in the days where parents set the egg timer when kids were talking to their grandparents long distance. It would probably also result in Verizon (NYSE:VZ) and AT&T (NYSE:T) going bankrupt in a very big hurry.

Balance of Productivity Gains

Historically, the gains from productivity have been shared between the owners of capital and the workers. However, over the last decade or so almost all the gains have gone to capital. While capital definitely deserves to be compensated -- after all, they provide the truck -- having it capture all the gains means that gains in productivity have not translated into the traditional role of raising standards of living. It simply results in higher and higher levels of income inequality.

The U.S. has by far the greatest level of income inequality in the industrialized world. The best single measure of income equality or inequality is known as the Gini Index (named for a 19th Century Italian mathematician, nothing to do with Barbra Eden in a bottle).

The Gini Index ranges between 0 and 1, with 0 being sort of a Marxist wet dream of everyone in a country having exactly the same income (when tried their way it both never works since party insiders have a lot more than the workers and peasants, and to the extent it works everyone equally has nothing). The other extreme would be Czarist Russia on steroids, where one individual or family gets all of the income in an entire country.

The Gini Index is regularly computed by the CIA as part of it World Factbook (also computed by the World Bank). The data is not for the same year in each country, but for most countries it is from within the last decade. The most equal countries in the world are the Scandinavian countries, with Sweden the lowest at 0.23, closely followed by Denmark at 0.24. Europe as a whole (the EU) is at 0.307.

So where is the U.S. on this list? At 0.45. Which are the countries that have a distribution of income that most closely match that of the U.S.? Cameroon, the Ivory Coast, Uruguay and Jamaica.

Falling Unit Labor Costs Key

The plunge in unit labor costs is the flip side of higher productivity, especially when the higher productivity is not shared with the remaining workers through higher wages. For many companies, wages are by far the largest expense item on their income statement. So if you can make and sell the same number of things, and do so with far fewer workers, your profits will soar. Profits can even go up if sales go down, provided your costs go down faster.

While there are some special factors that affected them (mostly due to year-ago ugliness), year over year the total net income of the S&P 500 firms that have reported is almost double the year-ago levels, while total revenues are up less than 6%. Even if you strip out the Financial sector which had all the real ugliness a year ago, total net income is up 12.5% while revenues are up just 2.2%.

That is massive net margin expansion. The rising productivity and the falling unit labor costs are the key driver of this. Overall, the increase in productivity is a very good thing, but much more so for investors than it is for workers.

Source: Increased National Productivity: Better for Investors Than for Workers