Why have the dynamics of labor productivity changed?

Abstract

The strength of the nascent economic recovery--and of the labor market--will depend importantly on labor productivity. By itself, faster productivity growth contributes to faster output growth. At the same time, stronger productivity gains allow firms to increase output without adding workers. Some analysts believe that faster productivity growth contributed to the “jobless recoveries” after the 1990-91 and 2001 recessions. ; In recent years, the U.S. economy has undergone a change in the behavior of productivity over the business cycle. Until the mid-1980s, productivity growth rose and fell with output growth. But since then the relationship between these two variables has weakened, and they have even moved in different directions. ; Fluctuations in productivity depend on two factors: the mix of shocks that drive the business cycle and the transmission of those shocks to output and labor market activity. Thus, two hypotheses stand out as plausible explanations for the change in the cyclical behavior of productivity. First, a decline in the importance of supply shocks for the business cycle may have changed the relationship of productivity and output over the business cycle. Second, structural changes in the labor market may have altered the transmission of shocks to the labor market and production. Specifically, a different labor market environment may have prompted firms to modify the way they meet their labor needs in response to shocks to the economy. ; Van Zandweghe examines the shift in the behavior of labor productivity over the business cycle and assesses the supply shock and structural change explanations for the shift. He finds that the importance of supply shocks in the business cycle has been stable over time. However, the behavior of productivity over the business cycle has shifted in response to both supply and demand shocks. Together, these results imply the shift in the business cycle behavior of productivity is most likely the result of structural changes in the labor market.