As humans, we are biased to the present. We indulge today’s gratification and obsess over current threats, all while too often disregarding developments that could shape our futures. Procrastination, risky behaviors, the absence of self-control, and impulsive decision-making are human traits associated with exaggerated short-termism.
We can see that behavior everywhere today. Market participants are tormented by fears of inflation and war. Of course, their preoccupation is also understandable. Stubbornly high inflation could prompt harsh tightening from central banks that could, in turn, jeopardize the global expansion. A Russian invasion of Ukraine could result in disrupted energy supplies, soaring oil and gas prices, recession or worse.
Moreover, as we’ve written on these pages before, assessing the probabilities of war and its many potential ramifications is fiendishly difficult—even for experts, never mind for investors and their advisors. And caution is warranted, given the potential severity of the outcomes.
As for inflation, we’ve also noted that it is likely to peak of its own accord this year, which if recognized in real time by central bankers, will permit a soft landing for the economy in 2023. Here, too, prudence dictates that investors gird for volatility in the near term, though all should resist the temptation to believe Wall Street inflation hyperbole.
Still, we return to the future. If we can force ourselves to disengage from the moment, we may recognize that potentially significant developments are taking place that could reshape our thinking about growth, profits, and investment opportunities over the remainder of this decade.
The tantalizing evidence comes from productivity statistics. As economists universally point out, few things matter more for our future well-being than productivity. What each worker fashions for herself dictates living standards. Productivity drives sustainable returns on assets. It determines real interest rates. And it sets the speed limit for the economy.
Yet since the early 2000s, economists have been puzzled by weak US productivity. The puzzle stems from the realization that while we live in an era of unprecedented innovation, we have also endured nearly two decades of uninspired productivity growth. Smartphones, 3D printing, the internet of things, electronic vehicles, autonomous vehicles, genetic sequencing, biomedicine, and so much else in the world of technology characterize an age of invention.
And yet productivity growth in the past fifteen years has been generally disappointing. After averaging over 2.5% annual growth from 1997-2004, US non-farm output per hour worked has slumped to rates of growth less than half that since 2005. Growth in output per hour worked in manufacturing averaged nearly 5% in the decade from 1997 to the financial crisis, but has slumped to about zero percent since then.
That may now be changing. A productivity stirring is becoming apparent. From its nadir in 2011, non-farm output per hour of work has been gently accelerating. In the two years before the onset of the pandemic, the annual gain in productivity averaged more than 3%, its fastest pace of non-recessionary growth since the early 2000s (note that productivity tends to rise in early recovery phases from recession when GDP accelerates faster than employment).
Notably, the gains in total non-farm productivity growth in recent years have not been matched by similar gains in manufacturing productivity. The implication is that the nascent acceleration of productivity is being increasingly driven by services. That’s novel, insofar as during the entire postwar period manufacturing has been in the productivity driver’s seat, while services have brought up the rear.
Why that is happening remains unclear. In the past, education, government and healthcare services have been the productivity laggards. Partly, measurement is the problem. How do we capture illnesses prevented, lives saved or other measures of healthcare achievement? How do we capture the value of education or government social programs?
Still, it is not far-fetched to assume that technologies long-since adopted in other areas, such as effective data management, are now being applied to sectors that were initially slow to adopt them. For example, medical records and patient-doctor information exchange are finally being digitized and captured more efficiently. The same may be occurring in social or educational services.
For advanced economies, these developments are potentially significant. Across Western Europe, Japan, and the US, manufacturing accounts for less than a fifth of GDP. Services, on the other hand, employ nearly 80% of the workforce. They also make up a dominant share of listed companies’ reported earnings. If productivity growth in services is beginning to accelerate, overall livings standards are set to rise, as are sustainable corporate profits, and the overall rate of GDP growth that can be achieved without stoking inflation pressures.
A few caveats are in order.
First, during Covid, significant disruptions occurred on the supply and demand side of the economy. It remains premature to know which will prove to be temporary and which may have fundamentally altered the way economies work. It would be foolhardy to extrapolate the 2011-2020 improvements in productivity until those shocks are more fully understood.
Second, we must differentiate between innovation and productivity. Many of today’s most visible advances, such as smartphones, streaming services, or social media innovations serve consumers rather than production. They offer us entertainment, but do not enhance our ability to produce. They don’t make us more productive.
Other innovations are, at best, marginal. Fancy aircraft or even electric vehicles may make flying more comfortable or allow us to feel less guilty about driving, but they do not make us more productive.
Only genuinely transformative technology, which either displaces old and inefficient ways of doing things or partners with other innovations to allow us to do things previously unthinkable will move the productivity dial.
Still, it would be incorrect to dismiss the data. Something is afoot. And if services productivity is genuinely trending higher, real incomes, profits and sustainable GDP growth will follow.
For all that ails the world today, services productivity growth could prove a welcome offset. But we’ll only recognize it if we allow our minds to look upward and gaze to tomorrow, ignoring for a moment what troubles us today.