In macroeconomics, few things matter more than productivity. It is the source of rising living standards and is what separates economies that are successful from those that are less so. It is the foundation for future income growth. In a world saddled with massive stockpiles of public and private sector debt, growing income to meet those obligations requires sustained strong productivity growth.
Paul Krugman put it best when he noted that ‘productivity isn’t everything but, in the long run, it is almost everything’.
Presently, many economists are doing a lot of head scratching about the prospects for productivity growth. They are right to do so. Productivity growth will hold the key to how sustainable global growth will be in the face of post-pandemic economic, policy and financial market pressures.
So, what are the prospects for productivity growth?
The answer depends on which country or region is being assessed and over what time frame. But there are a few key factors that augur well for productivity growth in many of the world’s major economies.
Firstly, productivity growth has accelerated across various measures in the US, Eurozone, and the UK since 2019. After meandering around 1% annual growth from 2013-2018, the rate of growth of labor productivity has roughly doubled in recent years in those same three regions. To be sure, cyclical factors may be partly responsible and the Covid crisis makes it more difficult to discern trends. Nevertheless, the strength of the current rebound in productivity growth is impressive.
One potential contributing factor is surging corporate investment activity, particularly in the technology space. Private investment in information-processing equipment has risen by over 10% in the US in the past year and is increasing at a rate well above its long-term trend. Surveys of CEOs and CFOs suggest they expect to maintain high investment rates going forward. A similar query by the World Economic Forum indicated that between 85 and 95 percent of firms were accelerating, or looking to accelerate, the digitization of work processes because of COVID-19.
Indeed, the COVID pandemic has generated behavioral shifts necessitating an acceleration in digitization and automation. Potential productivity efficiencies lurking beneath the surface prior to the pandemic are being discovered and magnified more swiftly than might have been expected in the absence of the pandemic. The most obvious example is breakthrough vaccine technology derived to fend off the virus, a technology that may well trigger further efficiencies in health care and immunization. Other examples of innovation abound, such as online healthcare access and provision, digital application to construction, the expansion of cloud computing, data and video exchange, the acceleration of e-commerce activity and the accelerated shift to electronic payments in banking.
Some of the statistics are staggering. The share of internet sales in total UK retail sales has jumped by ten percentage points, with online sales nearing one third of all such spending.
That brings us neatly to the next factor, namely the sheer number of new technologies that could yield a productivity dividend this decade. To be sure, much hype exists about new technologies, often wrapped up in the label of a ‘fourth industrial revolution’. Nevertheless, artificial intelligence and machine learning, biotechnology, nanotechnology, robotics, and 3D printing—to name but a few—represent a stunning pace of innovation and technological change with considerable promise to alter the way we make things, think about things, and engage with one another. They are the seeds of new growth and new sources of efficiency.
This raises an important question. Why have the nascent technologies not already delivered higher economy-wide rates of productivity growth?
The answer may be that the absence of a broad-based productivity revival before the pandemic had little to do with technology. Rather, the bottleneck may have been surplus labor market capacity and low real wages.
A growing body of evidence increasingly suggests that low real wages played a significant role in driving productivity growth to weaker levels in the years following the financial crisis. When real wages are low and profit margins high, firms had few incentives to deploy new technology and/or seek alternative ways of securing cost efficiencies. Companies were fat and happy, and not driven to innovate.
The parallel view is that low labor productivity growth may have been a symptom of demand-constrained, cheap-labor economies. It may be no coincidence, therefore, that labor productivity growth and capital expenditures are rebounding as easy monetary and fiscal expansions stoke wage growth. With sources of labor supply no longer as plentiful as they used to be (viz, slowing globalization), firms are incentivized to invest in and deploy new technologies.
What does this mean for productivity trends?
As stated above, many economists have been at a loss to explain tepid productivity growth in recent decades despite the explosion of new technologies. But they are beginning to take a more optimistic view. In the US, the median forecast from a survey of professional forecasters for 10-year average annual labor productivity has risen from 1.35% in 2019 to 1.75% in the latest poll. Based on innovation and investment, it is now possible to forecast that trend productivity growth might accelerate between 0.5% and 1.0% in most advanced economies over the next decade. That welcome development would restore OECD productivity trends roughly to where they stood prior to the financial crisis.
This encouraging productivity view is, however, contingent on several factors, not least of which is sound economic policy. Rising trend output requires sufficient aggregate demand to avoid the emergence of financial imbalances and to mitigate dis-inflationary pressures. Policymakers will need to be cognizant of shifts in trend productivity growth as they consider appropriate monetary and fiscal policies.
Simply put, if major economies are about to embark on faster trend growth, monetary policy can remain looser for longer and today’s high levels of government debt are more sustainable. Proper policymaking is always a judgment call, but the evidence suggests that overreacting to fears of inflation or indebtedness may prove to be a miscalculation.