Solid productivity growth supports US exceptionalism

We now see as the consensus view that the current productivity surge is sustainable.

Nonfarm business sector labor productivity grew a modest 1.2% annualized in Q4 2024 as economic output rose 2.3%, and hours worked increased 1.0%. Meanwhile, unit labor cost rose a solid 3% in Q4 as compensation growth picked up to 4.2%.

The annual trend in productivity growth cooled 0.5 percentage point (ppt) to 1.6% year over year (y/y) in Q4 2024 — its lowest since Q2 2021. Still, it remains near the upper end of the 2010–2019 range (excluding recession-induced distortions when productivity surges because labor falls faster than output).

On average, in 2024, nonfarm business productivity grew 2.3%, the strongest pace since 2004 outside of the pandemic and global financial crisis recession surges. As we have previously stressed, this type of pro-cyclical productivity momentum has only occurred once in the past two decades, during the 2000–2005 period.

Strong compensation is a luxury that businesses can only afford in a high-productivity growth environment that helps curb elevated labor costs. Indeed, despite solid compensation growth at 4.3% y/y in Q4, unit labor costs only rose 2.7% y/y in Q4 — down from a peak of 6.4% y/y in 2021.

In Q4 2024, headline Employment Cost Index (ECI) compensation eased 0.1ppt to 3.8% — the slowest pace since Q3 2021. A rebalanced labor market means that ECI compensation will likely converge toward 3.5% over the next 12 months — roughly in line with the pace consistent with the Fed’s 2% inflation target given productivity growth at 1.6% (2% + 1.6% = 3.6%).

Pro-cyclical productivity growth, a resilient labor market and strong household income gains remain the pillars of US exceptionalism. If firms can sustain robust productivity momentum, they will be able to manage costs and protect margins without compromising talent, even in an environment of still-elevated wages. This dynamic becomes even more critical as tariffs push up the cost of goods sold.

We have long held — and now see as the consensus view — that the current productivity surge is sustainable. Factors underpinning this acceleration include a more experienced and better-trained workforce, strong business formation, strategic efficiency gains to offset high wage bills, and prudent business investment despite elevated interest rates. While the productivity boost from generative AI has yet to materialize, it is poised to ride the wave of this momentum.

Crucially, this is not a given and should not be taken for granted. Policy missteps, such as overly restrictive regulations or sudden shifts in monetary policy that could unsettle capital markets, pose significant risks. Additionally, protectionist trade policies could disrupt global supply chains, undercutting business formation and strategic investments crucial for sustaining productivity gains.