Data released Thursday by the U.S. Bureau of Labor Statistics revealed that U.S. labor productivity growth in the second quarter outpaced market expectations. As companies continue to ramp up investments in artificial intelligence (AI) and technology while managing rising costs, business efficiency has improved further. Meanwhile, the increase in unit labor costs came in below forecasts, offering a positive sign for the Federal Reserve's efforts to control inflation.
The report showed that nonfarm business productivity, measured as hourly output, rose at an annualized rate of 1.4% in the second quarter. This figure exceeded the consensus forecast and marked an acceleration from the revised 0.8% growth in the first quarter, which itself was revised up by 0.5 percentage points from the initial estimate. Concurrently, unit labor costs rose at an annualized rate of 1.3% in the second quarter, missing market expectations and matching the revised 1.3% pace from the first quarter. This suggests that businesses have effectively mitigated cost pressures through efficiency gains, even as wages rise.
Productivity gains driven by faster output growth, sustained efficiency improvements at firms
Looking at the components, the improvement in second-quarter productivity was largely driven by a notable acceleration in business output. According to the data, nonfarm business real output grew at an annualized rate of 1.7%, while total hours worked increased by just 0.3%. The faster pace of output growth relative to hours worked boosted productivity further. On a year-over-year basis, nonfarm business productivity rose by 2.2% in the second quarter. The Bureau of Labor Statistics noted that the quarterly productivity gain reflects businesses achieving higher output efficiency while maintaining a lower rate of employment growth. The output growth in the second quarter was the fastest since the third quarter of 2025. Since the start of the current business cycle in the fourth quarter of 2019, nonfarm business productivity has grown at an annualized rate of 2.1%, surpassing the 1.5% rate seen during the previous cycle from 2007 to 2019 and aligning with the long-term average of 2.1% since 1947.
Effect of AI investments still under observation, official conclusions remain premature
In recent years, the Federal Reserve, economists, and investors have closely monitored whether the hundreds of billions of dollars in corporate AI investments are beginning to translate into productivity gains. U.S. companies, including major tech firms, are increasingly investing in AI infrastructure, with capital expenditure on data centers, GPUs, and memory chips growing rapidly. There is widespread anticipation that AI could spark a new productivity revolution. However, current official data makes it difficult to draw a definitive conclusion about AI's impact on overall productivity. The Bureau of Labor Statistics stated that quarterly productivity data is volatile and that the long-term effects of AI investment will require more time to observe. Meanwhile, AI investment has fueled a surge in data center construction, driving demand for memory chips, servers, and other tech hardware, and pushing up prices for related products. Additionally, rising energy and transportation costs due to geopolitical tensions in the Middle East continue to erode real household incomes.
Moderate rise in unit labor costs helps ease inflation pressures
For the Federal Reserve, one of the most significant aspects of rising productivity is its potential to alleviate the inflationary pressure from wage increases. The data showed that unit labor costs rose by just 1.3% in the second quarter, a result of hourly compensation increasing by 2.7% and productivity growing by 1.4%. Because productivity improved concurrently, the increase in labor costs per unit of output was noticeably restrained. Over the past four quarters, unit labor costs have risen by a cumulative 1.4%. The Bureau of Labor Statistics explained that unit labor costs are essentially the ratio of hourly compensation to productivity. Therefore, wage increases typically push unit labor costs higher, while productivity gains help lower the metric. After adjusting for inflation, real hourly compensation fell at an annualized rate of 3.1% in the second quarter, the largest decline since late 2022, and has declined by 0.1% over the past four quarters. Furthermore, labor's share of total business output fell to 52.9%, the lowest level since records began in 1947. This indicates that the profit share is rising while labor's share of national income continues to decline.
Manufacturing productivity also improves, durable goods sector shows stronger performance
Beyond the nonfarm business sector, manufacturing productivity also improved in the second quarter. The data showed manufacturing productivity grew by 1.9%, driven by a 4.6% increase in manufacturing output and a 2.6% rise in hours worked. Within this sector, durable goods manufacturing productivity rose by 2.7% alongside a 7.3% increase in output, while nondurable goods manufacturing productivity increased by 2.0%, primarily due to a 0.5% decline in hours worked. On a year-over-year basis, manufacturing productivity overall grew by 0.9%. Unit labor costs in manufacturing were essentially flat in the second quarter, as a 1.9% increase in compensation was fully offset by an equal gain in productivity. However, over the past year, manufacturing unit labor costs have still risen by a cumulative 3.5%. The Bureau of Labor Statistics noted that since the start of the current business cycle (end of 2019), manufacturing productivity has grown at an annualized rate of 0.5%, which is significantly higher than the 0.1% rate during the previous cycle but still below the long-term average of 2.1% since 1987.
Warsh: AI will ultimately be a significant force for long-term disinflation
Federal Reserve Chair Warsh has previously stated his belief that artificial intelligence will ultimately help ease long-term inflationary pressures. During a Senate hearing on July 15, he stated, "I believe that over time, productivity gains will have a deflationary effect at a structural level. I think that wherever technology touches, it ultimately becomes cheaper." However, some economists caution that if AI continues to boost business efficiency, it could lead some companies to slow hiring or even reduce their workforce in the future, presenting new challenges for the labor market. Therefore, how AI will ultimately reshape the U.S. labor market will require further validation from future data.
Comments