The Index of Small Business Optimism rose 0.1 points to 105.3 in August, basically unchanged from July. Five of the 10 Index components posted a gain and five declined. The Index peaked for this recovery at 105.9 in January, just 0.6 points above the August reading. It is unlikely that progress in Washington D.C. is the source of continued owner optimism because there isn’t any on the major issues of health care and tax reform. So owner optimism is more like a “relief rally”, relief that they did not get another four years of costly federal regulations which increased the hold of government on the private sector. The Congressional Record is nearly empty compared to years of record new and changed regulations posted for the past eight years.

“Productivity” increased 0.1% in the first quarter and 0.9% in the second quarter (annual rates). Did workers get that much better in three months? Not likely. Defined as a change in “output per hour worked,” its measurement has occupied economists for decades. Consider the productivity of an employee at a burger joint. The number of burgers served per hour measures productivity. But this varies with the economy; in good times, there are more customers and in bad time fewer. But the fundamental skills of the burger server do not change. These “skills” and the available capital equipment will determine over the long run what the worker’s productivity CAN be. What it WILL be depends on how many customers actually buy a burger. There was no amazing improvement in worker skills from the first quarter to the second, just a change in demand which resulted in more sales per hour for the existing employees.

Some argue that sluggish productivity growth can slow economic growth and prevent wages from rising much. For the burger worker, it is slow economic growth that reduces the number of burgers purchased per hour, it is not the employee’s ability to deliver burgers. Only if the demand for burgers reaches the limits of the worker to deliver them could the employee’s productivity limit growth, a “supply” problem that can be alleviated by hiring another worker or getting a machine or a reorganization of the burger production line (management skills).

Strong demand results in better utilization of capacity and creates new jobs, all of which comes about through higher wages paid to attract applicants and keep good employees. The reverse is not true. Mandating a $15 minimum wage will not increase the number of burgers served per hour by the employee to cover the higher wage cost. That will only raise costs for the business which will have to raise prices to recover those costs or fire an employee if burger demand falls due to higher prices.

One simple fact holds true: employee compensation can rise in real terms over time only if employees produce more stuff per hour e.g. productivity rises. This depends on both supply and demand factors. To make sure that the employee CAN produce more if asked, we invest in training, research, technology, improved equipment, all to increase the capacity to produce. However, demand plays an important role. The employee can’t produce more burgers per hour unless there are sufficient customers to make it happen. Thus, the need for pro-growth policies which will help finance the capital investments needed to improve long-run productivity.

Second quarter GDP growth was revised up to 3 percent (annual rate) revealing stronger consumer and private sector spending which raises the odds that the Federal Reserve will raise rates again. With little good news from Washington D.C., it appears that owner optimism is holding at record levels because of private sector activity on Main Street, a reason to hire and build inventories and make capital purchases. Eventually, something will happen to taxes and health care, presumably improving on the current situation, so at least the outcome will not be a negative for owners.