As a component of total productivity, the growth of labor productivity is one important marker in determining the rise or fall of overall economic growth. As of the present, however, labor productivity is simply another statistic number reported in government agencies.
The interest in this number is hinged only on the belief that it is related to a number of things important to economists and government policy-makers. It is thought to be connected to overall economic growth, real per capita income growth, and inflation.
Economic growth
Labor productivity growth and overall economic growth are definitely relevant to one another. By definition, the sum of growth of labor hours plus labor productivity growth is the output growth. (Higher labor productivity growth means higher output growth.)
Longer time periods make this relationship clear. For instance, output growth slowed down in the 70s and 80s as labor productivity growth slowed down. When labor productivity improved in the 90s, the output growth also rebounded.
However, there were time periods when these two were at variance. Experts think this is caused by business cycle forces affecting the demand and supply of labor. The swings in the quantity of labor affect the productivity fluctuations.
Per capita income growth
Economic textbooks declare that productivity growth and real wages growth are equal. By this assertion, it would seem that productivity growth is equal to the growth of real per capita income.
In real terms, this is not exactly correct.
There are several reasons for the variance. One, there is a multiplicity of produced goods. There is also a divergence between output price deflator used to compute productivity and consumer product price used in computing real incomes.
In addition, there is slippage between growth in wages per hour and growth in income per capita. This is caused by fluctuations in unemployment, labor force participation, and working hours per person.
Inflation
One question posed by experts is the following: If productivity growth is inherently a real phenomenon and inflation is a monetary phenomenon, why is there a relationship?
One possibility they had looked into is that higher inflation rates could distort the price mechanism. In turn, it could trigger reduced efficiency throughout the economy. Inflation may have a negative effect on capital accumulation.
The opposite could also be true. In periods of fast outputs and real income growth, it is easier for monetary authorities to impose anti-inflationary rules.
So far, the economists are not yet clear on any stable relations between inflation and either capital formation and technological change. By the same token, it is argued that inflation and productivity could be unrelated.
Nevertheless, the data are clear in showing links between productivity growth and inflation. It is shown that at longer intervals, the magnitude of their relationship grows. It seems that periods of high productivity growth are periods of lower inflation.
The interpretation by economists on the correlations between productivity and output, real per capita income and inflation are further clouded by other economic factors. Further studies are still to be done.
However, one thing is evident. Labor productivity growth is not just a statistic number but an important component in total economic growth as seen even from a laymans point of view.