U.S. productivity dropped in the first quarter by the most since 1947 as the economy shrank, while labor costs surged and illustrated an extremely tight job market.

Productivity, or nonfarm business employee output per hour, decreased at a 7.5% annual rate from the previous three months, according to Labor Department figures Thursday. That compared to a 6.3% gain in the fourth quarter and the 5.3% projected decline in a Bloomberg survey of economists. 

While productivity growth rates can be extremely volatile in normal business cycles, the pandemic and subsequent recovery over the past two years has made the figures more prone to fluctuations. It’s likely to take several more years to gauge whether underlying productivity trends have shifted in the wake of COVID-19.

Hourly compensation rose 3.2% in the period, but with the drop in productivity, unit labor costs climbed at a 11.6% rate in the first quarter. While the quarterly gain in hourly compensation adjusted for productivity likely overstates the degree of wage pressures, the 7.2% annual gain in labor costs was the largest since 1982.

“The trend in unit labor costs is running more than double the Fed’s inflation goal of 2%, signaling inflation pressures persist not only outside the U.S. with elevated commodity prices and still-knotted supply chains, but from within as the U.S. labor market remains exceptionally tight,” Sarah House, senior economist at Wells Fargo & Co., said in a note.

The U.S. economy contracted last quarter for the first time since 2020, largely due to a wider trade deficit as companies imported more goods and services to support robust consumer demand. 

Nonfarm business output as measured by this report, which is about 75% of GDP, also shrank for the first time in nearly two years. That slowdown depressed the government’s measure of productivity growth.

Economic output declined at a 2.4% pace in the first quarter, according to the report. Hours worked, the other input in productivity calculations, increased 5.5%. On a year-over-year basis, output per hour fell 0.6%.

Competitive Landscape

Fierce competition for a limited supply of workers has led businesses to bid up wages to attract and retain talent. By another measure, employment costs are now rising at a record rate. To help limit the impact of rising costs on balance sheets, firms often adopt new technologies or invest in equipment to make their workers more productive. 

More generally, rising productivity can help offset the inflationary impact of wage increases. 

Despite the rapid increases in wages, though, they’re still not keeping up with inflation. Real average hourly compensation fell an annualized 5.5% from the prior quarter after falling 0.5%.

Separate Labor Department figures Thursday showed applications for state unemployment benefits climbed to 200,000 last week from 181,000. While the latest print is the highest since mid-February, jobless claims remain near historic lows.