Friday, September 6, 2013

The Impact of Sorting and Effort on Productivity During Recessions

As an employee, have you ever wondered whether your employer understands the effectiveness of positive and negative reinforcement, particularly the threat of losing your job, on your performance and output?   Does that raise result in higher productivity or is the threat of a potential layoff more effective at milking that extra bit of effort? Does a recession have an impact on productivity levels because employers get rid of non-performers or because workers are willing to put in that extra effort to avoid the stigma of unemployment?

An examination of the issue by Edward Lazear, Kathryn Shaw and Christopher Stanton in a paper entitled "Making Do With Less: Working Harder During Recessions" looks at what happened to productivity during the period from December 2007 to July 2009, the official beginning and end of the Great Recession.

Let's open with this graph from FRED showing output per hour of all persons in the nonfarm business sector for the aforementioned period of time:

At the beginning of the Great Recession, output per hour was 96.187, rising to 99.499 by the end of the contraction, not exactly what one would expect.  Over the latest recession, aggregate output dropped by 4.35 percent but the aggregate number of hours worked dropped by even more, falling by 10.54 percent.  This means that labor productivity rose, in fact, it rose by 3.16 percent in nonfarm businesses.  This is not generally the case historically; in recessions before the 1990s, productivity dropped and the decrease in labour is generally less than the decrease in output.  In Europe, this was the case even in the latest recession as shown here, noting that the dotted red line (United States) is heading in the opposite direction to the major European economies including Germany, Italy, France and the United Kingdom:

The difference between Europe and the U.S. could be related to Europe's policies on restricting firings and the areas intentional employment retention policies, a policy that clearly does not exist in the increasingly non-union workplace in America.  

Why did productivity rise even as employment fell in the U.S. during the Great Recession?  There are two possibilities as follows:

1.) Sorting: The quality of the workers that retained their jobs during the Great Recession were of better quality than in the period before the recession.  This is referred to as "sorting" whereby employers layoff their less productive workers (laggards) and keep their more productive workers (stars).

2.) Effort: The workers that were employed during the great recession were of the same average quality as before the Great Recession but were able to produce more because they made more of an effort.  This is known as the "making do with less" since employers are able to get more production out of the same number of workers as they had prior to the recession.  Workers, knowing that there is a greater chance that they might be laid off, may be willing to trade a higher degree of effort for a given level of compensation given that the option is termination for poor performance.

By studying data for one very large, multi-faceted nationwide technology services firm that employed 20,386 moderately skilled labourers and 5.1 million data points on daily performance measured by computer monitoring of activities from June 2006 to May 2010, the authors were able to measure the impact of "sorting" versus the impact due to "effort".

Productivity at the company in question rose from an average of 9.87 units per hour during the period prior to and after the recession and rose to an average of 10.76 units per hour during the period during the Great Recession as shown on this graph plotting both unemployment (red crosses) and the log of output per hour (OPH) (blue dots):

Output per worker during the recession rose by 5.33 percent.  During the recession, the company added employees, however, the growth rate of employment fell.  Note the rapid drop off of output after the Great Recession even though unemployment remained high.

Through the use of regression analysis, the authors were able to determine that:

1.) Laggards (poorer performers) were able to increase their productivity by 5.1 percent during the recession compared to stars (better performers) who increased their productivity by only 3.4 percent.

2.) A very tiny percentage of the productivity gains during the recession can be explained by the movement of lower quality workers out of the workforce and the resulting concentration of higher quality workers.

The main finding of the research is that this particular company, a reasonable representative of the economy as a whole, made do with less.  Increased effort by employees led to higher output rather than the sorting out of poorer performing employees.  What is even more interesting is that in areas of the country where unemployment was higher due to a more pronounced recessionary economic contraction, the productivity gains were the highest and the increase in effort was the most pronounced.

To summarize, the fear factor associated with unemployment, particularly in the last, very deep recession, caused people to work harder.  The spectre of having to find a job in a dreadful economy put the "fear of God" into Main Street America, causing workers to work harder and productivity to rise even as employment fell.  The implicit use of the "you're lucky to have a job" mantra can work wonders on a fear-ridden workforce, pushing us to work beyond our normal comfort zone in a desperate effort to remain employed.

Apparently, Corporate America is learning that they really can make do with less.

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