The fallacy of "productivity gains" in a recession

As the nation's economic recovery has struggled to gain traction, the monthly employment reports produced by the U.S. Department of Labor have been closely watched in the investment community and beyond. With the unemployment rate remaining stubbornly high, most Americans have become suspicious of the viability of another "jobless recovery".

Those who promote the concept of the so-called "jobless recovery" point frequently at improving labor productivity as a potential driver of economic growth. As the Los Angeles Times notes,

Productivity, defined as real output divided by hours worked, is one of the most important — but elusive — economic data points. Productivity gains, if the benefits are shared, can hold the key to better living standards, higher wages, increased profits and low inflation.

Simply put, real economic growth and high unemployment cannot coexist, unless those still employed are producing at a higher rate than they previously did. Good news!, say the "jobless recovery" talking heads. Even as our unemployment rate climbed above 10%, worker productivity was steadily increasing.

Businesses, forced by the recession to take a hard look at their business practices to cut costs, "got lean". Laying off supposedly unproductive workers, they were amazed to find that they were able to produce the same (or more) output with fewer workers. Fantastic! Maybe our businesses were all just massively inefficient all along, and it took a recession to get them to realize it.

The problem is, these productivity gains were fleeting. Already in the second quarter, worker productivity--as measured by the Labor Department--began to decline. Why is that? Simple. Over the long run, the only thing that can reliably increase worker productivity is improved technology--something, anything (say, a computer instead of a typewriter or a lawn mower instead of a scythe) that allows a worker to do more in less time. (Yes, there can be frictional exceptions when individual businesses are indeed inefficient and have truly unproductive workers on their rolls, but these rarely translate to the macro picture as would be displayed in Labor Department reports).

In this recession, no technological magic bullet has materialized to create these productivity gains (please, don't e-mail me and argue that the iPhone increases worker productivity). So what explains them?

Anecdotal evidence indicates that the answer may be largely psychological. When massive layoffs are occurring nationwide, workers naturally fear for their jobs, especially if coworkers have already lost their jobs. In the short run, these workers will be willing to work harder, doing the job of 1.5 or 2 employees to ensure that they, too, aren't sent to the unemployment line.

Initially, this dynamic creates productivity gains, which many companies mistakenly assume are sustainable. But eventually, this type of worker exertion leads to exhaustion, and ultimately a decline in worker morale. Whip a horse enough, and the horse gives up.

Two friends of mine here in Charlottesville have recently reached this point of exhaustion, and are now on the verge of quitting their jobs. Their respective companies will soon be scrambling, trying to replace productive workers and train them on the fly. It will be exceedingly difficult for these companies to hire and quickly train new hires to do the work of 1.5 employees that my friends were previously doing. After all, who's going to train them? All of the remaining employees are already overworked as it is.

Companies who make this mistake will suffer significantly in the coming months, and will find themselves in a strategically weak position if (and when) the economy does begin to recover. Overwork your employees, and you'll only hurt yourself in the long run.

[Los Angeles Times]