Productivity surge helps explain US economy’s surprising resilience

As Reata Engineering and Machine Works CEO Grady Cope looks on, a worker prepares a Hexagon machine to confirm that parts meet customers' standards, Thursday, Feb. 15, 2024, in Englewood, Colo. At Reata, which makes parts for aircraft and medical device manufacturers, "efficiency was kind of forced on us,'' Cope said. (AP Photo/David Zalubowski)
As Reata Engineering and Machine Works CEO Grady Cope looks on, a worker prepares a Hexagon machine to confirm that parts meet customers' standards, Thursday, Feb. 15, 2024, in Englewood, Colo. At Reata, which makes parts for aircraft and medical device manufacturers, "efficiency was kind of forced on us,'' Cope said. (AP Photo/David Zalubowski)

WASHINGTON (AP) — Trying to keep up with customer demand, Batesville Tool & Die began seeking 70 people to hire last year. It wasn't easy. Attracting factory workers to a community of 7,300 in the Indiana countryside was a tough sell, especially having to compete with big-name manufacturers nearby like Honda and Cummins Engine.

Job seekers were scarce.

“You could count on one hand how many people in the town were unemployed," said Jody Fledderman, the CEO. “It was just crazy.’’

Batesville Tool & Die managed to fill just 40 of its vacancies.

Enter the robots. The company invested in machines that could mimic human workers and in vision systems, which helped its robots “see” what they were doing.

The Batesville experience and others like it have been replicated countlessly across the United States for the past couple of years. Chronic worker shortages have led many companies to invest in machines to do some of the work they can’t find people to do. They’ve also been training the workers they do have to use advanced technology so they can produce more with less.

The result has been an unexpected productivity boom, which helps explain a great economic mystery: How has the world’s largest economy managed to remain so healthy, with brisk growth and low unemployment, despite brutally high interest rates that are intended to tame inflation but that typically cause a recession?

To economists, strong productivity growth provides an almost magical elixir. When companies roll out more efficient machines or technology, their workers can become more productive: They increase their output per hour. A result is that companies can often boost their profits and raise their employees' pay without having to jack up prices. Inflation can remain in check.

Austan Goolsbee, president of the Federal Reserve Bank of Chicago, has likened surging productivity to “magic beanstalk beans for the economy. ... You can have faster income increases, faster wage growth, faster GDP without generating inflation.’’

Joe Brusuelas, chief economist at the tax and consulting firm RSM, said, “The last time we saw anything like this was the late 1990s."

That was when a productivity surge — an early payoff from the sudden embrace of laptops, cellphones and the internet — helped allow the Federal Reserve to keep borrowing rates low because inflation remained under control even as the economy and the job market sizzled.

This time, the Fed's aggressive streak of rate hikes — 11 of them starting in March 2022 — has managed to help cool inflation from a four-decade high of 9.1% to 3.1% while causing little economic hardship.

  photo  A worker at Reata Engineering and Machine Works programs a Mazak Variaxis machine used to make semiconductor pieces, Thursday, Feb. 15, 2024, in Englewood, Colo. Reata, which supplies the aviation and medical device industries, has invested heavily in software that automates its manufacturing processes. It's also been training workers to use more sophisticated equipment. (AP Photo/David Zalubowski)
 
 

“I would have said it’s not possible,’’ said Sal Guatieri, senior economist at BMO Capital Markets. “But that’s exactly what happened.’’

A year ago, nearly every economist was warning that a recession was all but inevitable. Fed Chair Jerome Powell himself warned in 2022 that beating inflation would inflict “some pain" in the form of widespread layoffs and higher unemployment.

By last month, Powell was sounding a different note. With unemployment barely above a half-century low, the Fed chair told reporters, “We’ve had a very strong labor market, and we’ve had inflation coming down."

He did caution that the central bank wants to see further progress in slowing inflation. Yet the Fed is so optimistic that inflation is heading toward its 2% goal that it hasn’t raised rates since July and is expected to cut rates multiple times this year.

Perhaps the likeliest explanation is the greater efficiencies that companies like Batesville Tool & Die have managed to achieve in the past year or so. Before productivity began its resurgent growth last year, a rule of thumb was that average hourly pay could rise no more than 3.5% annually for inflation to stay within the Fed’s 2% target. That would mean that today's roughly 4% average annual pay growth would have to shrink. Yet higher productivity has changed that equation: There's now more leeway for wage growth to stay elevated without igniting inflation.

“A lot of that pressure on business finances — that normally causes them to raise prices — has been offset by strong productivity growth,’’ Guatieri said.

At a news conference this month, Powell was asked whether he believed higher productivity helps explain why the economy has kept growing steadily even while inflation has tumbled.

“That's one way to look at it — yeah,” Powell replied.

The productivity boom marks a sharp shift from the pre-pandemic years, when annual productivity growth averaged around a tepid 1.5%, according RSM's calculations. Everything changed as the economy rocketed out of the 2020 pandemic recession with unexpected vigor, and businesses struggled to re-hire the many workers they had shed.

The resulting worker shortage sent wages surging. Inflation jumped, too, as factories and ports buckled under the strain of rising consumer orders. Parts shortages arose.

Desperate, many companies turned to automation. Investment in equipment and in research and development and other forms of intellectual property accelerated. The efficiency payoff began to arrive almost a year ago. Labor productivity rose at a 3.6% annual pace from last April through June, 4.9% from July through September and 3.2% from October through December.

At Reata Engineering & Machine Works, “efficiency was kind of forced on us,’’ CEO Grady Cope said. With the job market roaring, the company, based in Englewood, Colorado, couldn’t hire fast enough. Meantime, its customers were starting to balk at paying higher prices.

So Reata installed robots and other technology to produce more with less. Software allowed it to automate the delivery of price quotes to customers. That process used to require two weeks. Now, it can be done in 24 hours.

Many economists and business people say they're hopeful, if not certain, that the productivity boom can continue. Artificial intelligence, they note, is only beginning to penetrate factory floors, warehouses, stores and offices.

“Right now, AI is not a critical enabler for us; it’s an assistant and accelerator in certain roles,’’ said Peter Doyle, CEO of Hirsh Precision, which makes parts for the aerospace and medical device industries. “The world is still trying to understand what AI is capable of doing and how quickly it will advance.’’

The early evidence suggests that AI could sustain the productivity gains. A study last year by Erik Brynjolfsson of Stanford University and Danielle Li and Lindsey Raymond of the Massachusetts Institute of Technology tracked 5,200 customer-support agents at a Fortune 500 company who used a generative AI-based assistant in 2020 and 2021. The AI tool provided suggestions for dealing with customers and links to useful internal documents.

Those using the chatbot were found to be 14% more productive than colleagues who didn’t use the tool. They handled more calls and completed them faster. The biggest gains in productivity — 34% — came from the least-experienced, least-skilled workers.

Automation tends to raise fears that machines will replace human workers and thereby kill jobs. Some workers supplanted by robots do often struggle to find new work and end up settling for lower pay.

Yet history suggests that in the long run, technological improvements actually create more jobs than they destroy. People are needed to build, upgrade, repair and operate sophisticated machines. Some displaced workers are trained to shift into such jobs. And that transition is likely to be eased this time by the retirement of the vast baby boom generation, which is causing labor shortages.

Some of today's productivity gains may be coming not just from advanced technology but also from more satisfied workers. The tight labor markets of the past three years allowed Americans to change jobs and find others that pay better and make them happier and more productive.

One of them was Justin Thompson, of Kalamazoo, Michigan, who had felt burned out by his job as a police officer, with its 16-hour workdays .

“I was literally running myself into the ground,’’ he said.

Thompson's wife saw a job posting for operations manager at a charter airline. Even without airline experience, his wife felt he could use skills he gains as a Marine Corps infantryman — handling logistics for missions — during tours in Iraq and Afghanistan.

She was right. Omni Air International hired him in 2019.

Thompson, 43, said he he loves the new job, which allows him to work from home when he’s not traveling. And his Marine experience — which included developing ways to improve efficiency — has proved invaluable. Technology helps, too: Thompson travels with a laptop, iPad and mobile printer and uses proprietary software to manage logistics.

Other workers have switched from low-skill jobs to those that pay better and are more productive.

“The people who were rolling tacos on Dec. 31, 2019 ... yeah, they’ve moved up,’’ RSM’s Brusuelas said. “They’re doing other things and making a lot more money."

At Reata Engineering, staffers were trained to use new sophisticated equipment. One 19-year-old employee, a university engineering student, has used AI tools to make company training materials less cumbersome and time-consuming.

“The whole point is not to lay people off,’’ said Cope, the CEO of Reata Engineering. “The point is to make people do jobs that are more interesting’’ — and pay better, too.

  photo  A box of parts for blood plasma pumps sits ready for shipping from Reata Engineering and Machine Works Thursday, Feb. 15, 2024, in Englewood, Colo. At Reata, which makes parts for aircraft and medical device manufacturers, "efficiency was kind of forced on us,'' CEO Grady Cope said. (AP Photo/David Zalubowski)
 
 

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