If Labor Supply Stops Growing, Productivity Carries More Weight

The U.S. employment report has a second horizon beyond the next unemployment reading: the economy’s capacity to produce output over time. This explanation focuses on the connection between potential employment, labor productivity, and potential GDP so you can see what a near-zero labor-force path changes—and what it does not. The central judgment is conditional: if potential employment contributes little to sustainable growth, productivity must account for more of any growth in potential output.

That conclusion is broader than saying that a weak jobs number is acceptable. It concerns the composition of growth, not the value of work or the welfare of workers. An economy can have a low breakeven employment pace and still face major questions about wages, job quality, sectoral demand, capital, and productivity. The demographic constraint changes one part of the growth arithmetic; it does not answer all of those questions.

Potential GDP has two moving parts

Potential GDP is the amount of real output an economy can produce when its labor and capital inputs are employed at their maximum sustainable rates. It is not the same as actual GDP in a particular quarter. Actual output can move above or below the sustainable path because of business-cycle conditions, temporary disruptions, or changes in demand. Potential GDP is an estimate of capacity, not a direct tally of what firms produced last month.

The Federal Reserve note uses a simple identity to show the two sources of potential output growth:

[ \text{GDP} = \left(\frac{\text{GDP}}{\text{Employment}}\right) \times \text{Employment}. ]

The first factor, output per worker, is the labor-productivity measure used in the note. The second factor is employment. If the number of workers rises while output per worker stays constant, potential output rises. If output per worker rises while employment stays constant, potential output also rises. In growth terms, the contributions of potential employment and productivity combine to determine the growth of potential GDP.

This identity is useful because it prevents a common leap. Slower employment growth does not automatically imply slower potential GDP growth by the same amount. It means that the productivity contribution must be larger if potential output is to grow at its previous pace. Conversely, strong productivity growth can support potential output even when the labor force is expanding slowly. The identity tells us where growth must come from; it does not tell us whether the required productivity growth will occur.

The historical record in the Federal Reserve note shows that both parts have mattered. From 1960 through 2025, CBO’s estimate of potential GDP grew by an average of about 3 percent per year. Potential employment contributed about 1.4 percentage points to that average annual growth, with the remainder attributed to labor-productivity growth. Most of the long-run growth in potential employment came from the growth of the labor force, which in turn was strongly connected to population growth.

This history is another reason the moving breakeven benchmark matters. When population growth and participation were adding workers, employment could make a large contribution to potential output while also determining how quickly jobs needed to grow to keep unemployment stable. When the labor force grows slowly, the employment contribution becomes smaller.