When an organization spends generously to retain employees and hire new ones, it likes to see employee productivity increase. But that's not happening in the U.S. economy. In fact, labor productivity is falling, even as workers get paid more, according to data released Tuesday by the U.S. Labor Department. 

The mounting cost of maintaining a stable, qualified workforce has been evident in many government data releases. The latest, from the Bureau of Labor Statistics, showed unit labor costs in the nonfarm business sector rose 10.8% in the second quarter, following a revised 12.7% jump in the first quarter. (See chart, Labor Costs Jump, Add to Price Pressures.)

What drives up the unit labor cost number, besides higher hourly compensation, is lower employee output per hour. The jump in labor costs reflected a 5.7% increase in hourly compensation and a 4.6% decrease in productivity. 

Productivity (output per hour) declined because total economic output fell 2.1% and hours worked (by all persons, including employees, proprietors, and unpaid family workers, according to the BLS) rose 2.6%. 

Last quarter was the second in a row in which economic output decreased while hours increased. (The first quarter saw a 7.4% fall in productivity). That makes the first two quarters of 2022 the weakest back-to-back since 1947, according to the BLS. (See the chart, Worker Productivity on the Decline.)

Few economists commented on the quarterly numbers because quarterly productivity measures can be highly volatile and immaterial to any long-term labor trend.

But Yelena Shulyatyeva and Eliza Winger, economists at Bloomberg, noted that productivity “declines of this magnitude are not sustainable — scorching labor costs will eventually lead to hiring freezes and outright layoffs unless there is a strong growth rebound. Increased recession odds suggest the former is more likely than the latter.”

Layoffs are certainly up, especially at tech firms that hired like gangbusters in the last few years. (Hootsuite announced Tuesday it was laying off 30% of its global workforce — as part of an effort to drive efficiency and financial sustainability.) But the more intriguing question is: besides highly cited instances of employee "burnout" and the possibility workers are more committed to their personal lives than their jobs, what else could be lowering productivity?

The job-hopping enabled by the intense competition for workers could be one factor.

The National Federation of Independent Business’s monthly survey showed that 21% of small business owners ranked “labor quality” as a top business problem, second only to the 37% choosing “high inflation.”

Hunt for Productivity

A tremendously tight labor market makes it more difficult to find highly productive workers, and even when a company manages to hire one, there’s often a lag until peak productivity. When more people switch jobs or retire, companies lose institutional knowledge as well as people who have already learned to navigate the company’s systems, processes, and management culture.

Although the manufacturing sector had an increase in productivity in the second quarter, some of its executives are highly aware of the issue.

On food distributor Sysco’s August 9 earnings call, according to S&P Capital IQ, CEO Kevin Hourican said though the company’s supply chain operations are now fully staffed, half of them have been with Sysco for less than a year. “And it's that point, that point alone, that results in a productivity rate that is below ... our historical average,” Hourican said. “These are challenging jobs. They're skilled labor positions, and it takes time for someone to move up the productivity curve.”

Indeed, overall supply chain disruptions have made it difficult for companies to achieve structural productivity gains. But the issues also provide some opportunities for efficiency initiatives down the road.

Said Joseph William Reitmeier, CFO of heating and air conditioner manufacturing Lennox International, at the Jefferies Global Industrials conference on Tuesday: “Just the absence of bad news will give us a tailwind, but then all the proactive things that we do on driving productivity whether it be automation on the factory floor, improvement in processes, redesigning our products for lower cost. All those things are going to reinvigorate once we’re on the other side of this chaos.”