Labor Productivity Improvements: History and Future

Labor Productivity Improvements: History and Future

by Christian Kaylor

November 2, 2016

Labor productivity is the output of a worker in a given amount of time. If it takes you 10 minutes to change a car tire, that is your labor productivity for changing car tires. Put another way, you could change six car tires per hour.

Labor productivity is expressed as a ratio, like miles per hour. At 30 miles per hour, a car travels 30 miles in every passing hour. Step on the gas, and it can travel at 60 miles per hour – covering twice the distance in the same amount of time. A car is a machine that takes time and gasoline and converts it into distance. A faster car is a more productive machine; it goes farther in the same amount of time.

We can think of labor productivity in similar terms. Any time you make something, say a tuna fish sandwich, you are consuming your time and getting a sandwich in return. The speed at which you can make a tuna fish sandwich is your labor productivity for tuna fish sandwiches. If you speed up the process, you can either make more sandwiches per minute or you will use fewer minutes to make a tuna fish sandwich. Either way you are better off, because time is money and tuna fish sandwiches are delicious!

Labor productivity has major economic implications. Producing more goods – food, clothing, medicine, and transportation, for example – that make us better off with less effort translates into an improved standard of living. The wealth of the United States owes much to advances in labor productivity. Improvements in the standard of living can be achieved only with sustained increases in labor productivity.

Good for Business

Businesses, like people, are keenly interested in saving labor. According to the Bureau of Labor Statistics, labor costs represent about two-thirds of the value of output produced for the U.S. business sector. Building the same product with less effort saves a company money and allows it to sell products for less than the competition. We call this "improving labor productivity."

Labor productivity is a fancy term economists use to describe a simple concept. Let's return to our sandwich example. Imagine that it takes your friend John five minutes to make a tuna sandwich. We would say that the product of five minutes of John's labor is one tuna sandwich. Since there are 60 minutes in an hour, we could say that John produces 12 tuna sandwiches for every hour of labor. John's labor productivity, with respect to tuna sandwiches, is 12 sandwiches per hour. Simple, huh?

Now, let's say you want to start a tuna sandwich store and decide to pay John $10 an hour for making sandwiches. Remember, in one hour he makes 12 tuna sandwiches. Dividing $10 in wages by 12 tuna sandwiches means that you are paying John about 83 cents for every tuna sandwich he makes. How can you decrease the amount you're paying to produce a sandwich without cutting poor John's paycheck? You can do it by increasing his labor productivity.

We are talking about labor, but many things go into making a tuna sandwich: bread, a can of tuna, and mayonnaise are the key ingredients. In addition, John uses tools: a knife and a can opener. If John did not have these tools, he would have a much harder time putting together the sandwiches. Giving John better tools – an electric can opener, for instance – would improve his productivity.

There are many ways to increase labor productivity. Upgrading equipment is one common way. You could also improve organization, buy better raw material, and specialize parts of the process. You could buy John an electric can opener to replace his manual one, and buy bread that has already been sliced. Increases in labor productivity using techniques such as these have been occurring for many years.

Nontechnical Labor Productivity Improvements

Improved labor productivity is commonly associated with application of new scientific technology. However, nontechnical ideas can also profoundly improve productivity.

Adam Smith began his 18th-century economics classic, The Wealth of Nations, with a chapter called the "Division of Labor." He described the 18 separate assembly steps in making a single metal pin. He estimated that a single person, working alone, could make 20 pins in a day. He also observed that 10 people on an assembly line could make 48,000 pins in a single day – an output of 4,800 pins per worker per day. That's quite an improvement in labor productivity.

"The greatest improvement in the productive powers of labor, and the greater part of the skill, dexterity, and judgment with which it is any where directed, or applied, seem to have been the effects of the division of labor," Smith wrote.

Henry Ford's application of such techniques to the automobile assembly line is a well-known innovation that greatly increased labor productivity. Consequently, the price of cars dropped low enough for millions of Americans to afford one.

In Oregon, Portland inventor Henry Phillips in 1936 patented a new type of screw head that was specifically designed to allow assembly line autoworkers to more quickly and easily seat the screwdriver into the screw. The result: the Phillips head screw. By 1940, the Phillips head screw was the standard in the automotive industry. An early advertising brochure from the American Screw Co. touts the "hours saved" by using the Phillips head screw. Today, the Phillips head screw is commonplace.

The Oregon Employment Effect

It's been generations since Henry Phillips improved productivity with his revolutionary fastener. Yet innovation continues and the results are apparent in employment and production numbers.

From 1998 to 2015, Oregon's gross state product – the value of all goods and services produced in a year within the state's borders – increased from slightly more than $105 billion dollars to more than $215 billion dollars (2015 dollars). That's a doubling of output in 17 years!

That's an impressive feat, but there's another twist. Over the same period, Oregon's covered employment went from 1,562,859 to 1,779,200 workers. That 14 percent increase, while large, is dwarfed by the 105 percent increase in output. This implies that the average Oregon worker was producing much more (in dollar terms) than in 1998.

Over those 17 years, new businesses developed while others faltered. New jobs were created while others were eliminated. However, Oregon workers managed to roughly double their output while the workforce increased by only 14 percent. That's a great example of improved labor productivity.

The Current Boom in Productivity

The Bureau of Labor Statistics tracks U.S. productivity growth quarterly. These data paint a fascinating portrait of labor productivity today. From 1973 to 1990, U.S. nonfarm productivity grew at a relatively low annual average rate of about 1.5 percent. At that rate, it would take 47 years for productivity to double! However, from 1990 to 2000, the rate increased to an annual figure of about 2.3 percent per year. Then from 2000 through 2007 productivity surged ahead at 2.7 percent per year. That may seem like a small improvement, but at that rate, it would take only 28 years – slightly more than a generation – for productivity to double. Productivity gains have moderated more recently, averaging 1.2 percent annually from 2007 through 2013, a rate that is more similar to historical norms in the 1970's and 1980's.

What led to the increase in productivity growth in the 1990s? The consensus among economists points squarely at information technology (IT). During the 1990s, computers, databases, and e-mail largely replaced the office typewriter, card catalog, and memo. Through the late 1990s, these changes created real effects in speeding the growth of the U.S. economy. Today, these technological improvements have stabilized somewhat as the IT revolution has slowed. Offices continue to buy better computers and better software, yet the improvements seem relatively minor compared with those of the 1990s.

Experts believe the surge in productivity in the last decade was due to the two major recessions in a single ten year period. In both recessions, businesses were forced by a declining economy to lay off lower skilled, less productive workers to save money. To compensate for the employment decrease, businesses continued to invest in machines and computer technology to do more with fewer workers. The end result is a more efficient economy which requires fewer workers.

The Future of Productivity Growth

Economists who study labor productivity have noticed that, although personal computers first appeared in offices and factories in the 1980s, it wasn't until the mid-1990s that their effect was seen in productivity numbers. This has led to speculation that there is often a delay of several years between the introduction of an innovation and its ability to noticeably affect productivity. Perhaps the improvements could take place only once a "critical mass" of firms had access to computers and e-mail.

On the other hand, in today's highly competitive global economy, businesses seem eager to embrace any innovation that might give them an edge on the competition. It's quite possible that technological advancements being made today in nanotechnology, genetics, fiber-optics, and alternative energy will fuel productivity growth for decades.

Some people lament the loss of jobs that typically accompanies labor productivity improvements. Certainly, economic transition can be painful to workers trying to develop new skills in an ever-evolving workplace. Still, the bulk of the economic growth that Oregon and the nation have enjoyed has come from improvements in labor productivity. We did it by working smarter, not harder. Productivity growth comes from innovation – ideas that entrepreneurs like Henry Phillips bring to industry.