Economic Growth: Wages And The Productivity Paradox

Sluggish wage growth and weak productivity growth are two trends that investors and analysts need to keep an eye on next year according to Goldman Sachs’ “Top of Mind” end of year Global Macro Research report.

Productive in both the US and the UK remains depressed, despite lower unemployment and economic growth. For example, US productivity growth reached 2.2% on an annualized basis in Q3, a short-term high. However, productivity data is noisy, and like any economic figures, the data should be evaluated over a longer time horizon — not over a period of just three months. Over the last year, US productivity grew just 0.6%, exactly in line with the disappointing five-year annualized average and well below the long-run historical average of just over 2%. It other words, productivity is improving but there’s still a long way to go.

Similarly, the UK productivity growth increased to the fastest pace in four years during the first half of 2015 (latest data), but once again, underlying figures show a more gradual improvement. UK output grew 0.9% in Q2, the strongest quarterly growth rate in four years, however, output per hour has only risen by 1.3% over the past twelve months, which is little more than half its pre-crisis average of 2.2%.

It’s not clear what’s causing this “productivity paradox”, although Goldman speculates that the inadequacy of today’s statistics in capturing productivity gains made by technology could be to blame. Manufacturers are plowing a considerable amount of investment in the Internet of Things, a potential driver of productivity. According to the latest estimates from the International Data Corporation, manufacturers invested about $700 million in IoT in 2015 globally, and companies appear to be ramping up investment in headcount related to IoT as well.

Will 2016 bring an end to the productivity paradox? It’s not clear. For US productivity to return to more normal levels, Goldman estimates that productivity growth needs to go back to its 1.5% estimate of the current trend rate. However, investment in IoT devices/infrastructure (spending on IoT will reach nearly $1.3 billion in 2019) and the inability to measure productivity gains from IoT applications could continue to weigh on productivity gains going forward. A recent analysis by the Bank of England suggests a total of 95 million jobs could be at risk of automation in the UK and US.

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Economic growth: Productivity growth

Economic growth: Wages

Away from the productivity paradox, US wage growth has finally begun to show signs of a pickup. Hourly earnings and the employment cost index rose 2.3% and 1.9% over the last year, which isn’t the most impressive rate of growth, but these metrics have started to look a bit firmer in recent months. Compensation per hour grew 3.6% over the last year, and a variety of business and consumer surveys point to expectations for wage growth in the neighborhood of 3% over the coming year. Higher minimum wages are also having an effect on wage growth. New York State moved to raise the minimum wage for some fast-food workers to $15 an hour in New York City by the end of 2018 and in the rest of the state by mid-2021. Walmart (WMT) and McDonald’s (MCD) have both announced wage hikes at their outlets. Overall, US wage growth is accelerating.

The outlook is more concerning in Germany where unemployment keeps declining, but wages are only moving sideways. The unemployment rate dropped to 4.5% this year, a 30pp drop relative to the beginning of the year, however, hourly earnings growth slowed somewhat in 2015 when compared to 2014. Earnings including bonuses and other benefits grew by 3% for the year. Still, the combination of strong employment growth and near 3% wage growth implies that total German wage income is growing at around 4%, considerably stronger than the rate of below 2% in France and Italy.

In Japan, basic wages have seen some increase, but total wages have remained flat. The annual spring wage negotiations for big businesses resulted in an average salary hike of 2.35% including a base pay increase of 0.69%, an even larger boost than in 2014, which had marked the most substantial increase in the last 15 years. As a result, basic wages have risen around 0.3% year-on-year — the first positive growth in 10 years. That said, to keep labor costs under control, Japanese companies have been cutting bonus payments, which has held down total pay. Companies have attempted to keep total labor costs in line with headline sales, which have remained unchanged despite record-high profits.

Goldman expects 2016 to see more of the same for wage growth in Japan, German and the US. US wage growth should accelerate over the next couple of years to Goldman’s estimate of 3% to 3.5% of the full employment trend rate while German wages should continue to expand at 3% next year.