The problem is that rising employment has not been accompanied by any great growth in output. Official figures show that employment rose by 510,000 in the year to June-August, a rise of 1.8 per cent, whilst total hours worked rose 1.5 per cent. But the NIESR estimates that GDP fell in this period by 0.5 per cent. This means that rising employment is a sign of falling productivity. (It could be that GDP is under-recorded and/or employment over-recorded, but this is very unlikely to explain away all the apparent drop in productivity).
This matters because there has traditionally been a positive correlation (0.33 since 1979) between annual growth in productivity and annual growth in real profits. This has been especially the case in the early stages of recovery. For example, 1982, 1992-93 and 2003-04 all saw good rises in productivity and profits. They also saw big increases in share prices.
Which is why equity investors shouldn’t be too happy about increased employment. If productivity stays weak, profits won’t rise much and so we probably won’t get the early-cycle jump in share prices we usually enjoy. In fact, profits can only rise in real terms as productivity falls if one or more of two things happen:
- Wages fall in real terms, so workers incur the cost of falling productivity. This has happened in the last 12 months. But if rising employment strengthens workers’ bargaining power, it might not continue. And even if it does, it is not wholly great news for aggregate profits, because lower real wages probably means weak consumer spending.
- Commodity prices fall, reducing firms’ non-labour costs. Given their volatility, this could happen – though few are betting heavily upon it. But again, even if it does happen, there’s a drawback. The likeliest cause of a drop in commodity prices would be a weak global economy, which would hit exporters’ profits.
The message here is simple. Falling labour productivity is a cost that must be borne by someone – either in the form of lower real profits, or lower real wages, or lower real incomes of commodity producers. (Note the use of “real” here; falling productivity might lead to higher inflation, but this solves nothing.)
Employment growth without GDP growth is good for workers who’d otherwise be unemployed. But it is nothing for shareholders to celebrate.
What would be reason to celebrate, however, would be a reversal of the fall in productivity. It could be that one reason for the fall in productivity is that some firms have been hoarding labour in anticipation of an upturn. If so, then as GDP recovers, so too – to some extent - will productivity. And we could then see the usual pro-cyclical rise in profits and share prices.
Even this, though, would also have a downside. With forecasters expecting only 1.1 per cent GDP growth next year and 1.9 per cent in 2014, any bounceback in productivity is likely to be accompanied by falling employment. In this sense, good news for shareholders might well mean bad news for workers. The only way this could be avoided would be if productivity recovers as GDP grows significantly faster than expected. And it would be unwise to bet much upon this.
