Productivity Slumped and Labor Costs Rose in 3rd Quarter after Real GDP Growth Disappeared

As expected, the dramatic drop in real GDP growth in the 3rd quarter lead to a sharp deterioration in productivity and unit labor costs. This is normal early in a recession, as businesses are slow to shed talented employees until they are sure their services are not needed. Companies must balance the cost of hiring and training new employees versus the expected duration of a slowdown in demand for their products to optimize profitability.

The preliminary look at productivity shows 3rd quarter growth slowing to +1.1% QoQ annualized (consensus +0.7%) which was better than expected. But the relative improvement is tempored by the fact that the second quarter reading was revised down to +3.6% from +4.3% earlier. Output fell by -1.7% QoQ annualized in the 3rd quarter of 2008, while hours worked were cut an even larger -2.7%. This lead to a small net increase in output per hour.

Unit labor costs, rose more than expected, growing by +3.6% QoQ annualized in the preliminary 3rd quarter reading. Consensus had looked for an increase of 3%. In addition, ULC fell less than originally thought in the second quarter, falling only -0.1% QoQ annualized instead of the earlier reported drop of -0.5%. Compensation jumped a large +4.7% QoQ annualized, but is unlikely to continue heading higher as the recession evolves. The 5% jump in the inflation deflator, caused real compensation to fall -1.9% QoQ annualized, the largest decline since the 2nd quarter of 2007. The recession will reduce labor's bargaining power, and hours worked, which should help to reverse this trend toward higher labor costs in future quarters.