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Read moreNonfarm business sector labor productivity growth was unrevised at 2.2% annualized in Q3 as economic output rose 3.5% and hours worked increased 1.2%. Over the last six quarters, productivity growth has averaged an impressive 2.6% increase per quarter. This type of pro-cyclical productivity momentum has only occurred once in the past two decades, during the 2000–2005 period.
The annual trend in productivity growth cooled 0.4 percentage point (ppt) to 2.0% year over year (y/y) in Q3 2024. Still, it remains above the 2010–2019 range (excluding recession-induced distortions when productivity surges because labor falls faster than output) and the strongest since the early 2000s.
Strong productivity growth in Q3 was disinflationary with unit labor cost only rising a downwardly revised 0.8% in Q3 despite a solid 3.1% gain in compensation. The annual pace of growth of unit labor costs was also revised lower, easing 0.1ppt to 2.2% y/y in Q4 — down from a peak of 6.4% y/y in 2021.
The Employment Cost Index indicated that wage compensation growth is easing, but at 3.9% y/y in Q3, it remains elevated. As such, we should acknowledge that strong compensation growth is a luxury businesses can only afford in a high-productivity growth environment.
Overall, pro-cyclical productivity growth, strong household income growth and lingering fiscal tailwinds remain the key pillars of US exceptionalism. If firms can generate strong productivity momentum, they will be able to control costs and protect margins without sacrificing talent in an environment of still-elevated wages and fading pricing power.
We have been firm believers in what has now become the consensus view that the productivity surge was sustainable. Longer-tenured and better-trained employees, strong business formation, efforts to offset high wage bills with efficiency gains, and judicious business investment in a high-interest rate environment form the bedrock of this acceleration in productivity. The generative AI lift is not yet evident but will certainly ride the wave of strong productivity momentum.
The Federal Reserve is likely to cut the federal funds rate by 25 basis points at the upcoming Federal Open Market Committee meeting. We then expect a pause in the easing cycle as policymakers tread more carefully in search of a neutral policy stance amid unusually high regulatory, immigration, trade and tax policy uncertainty.
The views reflected in this article are the views of the author(s) and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.
