NCPA - National Center for Policy Analysis

Considering Productivity and Profitability

June 6, 2002

Many of us probably equate higher productivity with increased corporate profits. The more widgets each worker makes, the more his company can sell -- resulting in his company making more money. But that's not necessarily so.

In the last six months, output has barely grown, but hours worked have fallen sharply -- meaning that output per hour worked has grown at a healthy pace.

  • In the last quarter of 2001, productivity grew at an annual rate of 5.5 percent.
  • In the first quarter of 2002, it grew at a phenomenal annual rate of 8.4 percent -- the highest in 19 years.

But that doesn't necessarily translate into higher profits, and here is why:

  • If productivity grows in highly competitive industries, the benefits in the form of lower prices accrue to the consumer -- not a company's bottom line.
  • Conversely, profits can increase without productivity growth and one company can achieve greater profitability than its competitors by offering a more popular product and realizing sales at the expense of others in the industry.

Productivity gains, for the most part, come from cost savings, and the Internet has become an engine in the cost-savings process.

One reason productivity usually declines during recessions is "labor hoarding." Companies hold onto workers, even when demand drops off, leading to hours worked declining more slowly than output produced.

But that did not happen this time. One possible explanation is that when the economy was booming, companies could have used fewer workers to produce the same output, but because they were not forced to lay them off, they just assigned them to lower-priority tasks.

Source: Hal R. Varian (University of California-Berkeley), "Economic Scene: Productivity and Profitability: An Odd Couple in an Odd Recession," New York Times, June 6, 2002.


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