This week, the Bureau of Labor Statistics (BLS) releases its estimate of second quarter non-farm business productivity in the US. It is likely to be abysmal, with output per hour worked expected to fall at an annualized rate of nearly 5%. That’s because economic activity declined in the first half of the year, while the number of jobs created (and hence hours worked) expanded briskly. Accordingly, output per hour worked sagged.
What’s most concerning is not the short-term slump in productivity. It follows, after all, a spike as the economy initially roared out of the pandemic, spurred by economic re-opening and considerable monetary and fiscal stimulus. Rather, the most discouraging aspect of productivity growth is how weak it has been for over a decade.
Since 2011, output per hour worked has inched ahead at barely a 1% growth rate. Given that the labor force itself is only expanding at a similar rate, the implication is that trend growth in the US is roughly about 2% per annum.
In contrast, non-farm business productivity expanded at more than twice the current rate, on average from the end of the second world war until the early 1970s. Then, following the disruptions caused by the twin oil price shocks of the 1970s, output per hour work expanded at roughly a 2% rate from the early 1980s until the global financial crisis of 2008.
In short, American workers have been only able to muster half the productivity gains over the past decade that their parents and grandparents were able to achieve in the postwar era.
That matters because, in the long run, productivity determines living standards. If productivity grows more slowly, today’s generations will not be able to enjoy the increases in wealth (and perhaps health) that history suggests they might expect. This undermines a core tenet of the ‘American Dream,’ in which new generations are promised better living standard than their parents if they work hard.
Poor productivity, however, is a paradox. We live in an age of continuous, rapid, and transformative change. Invention pops into our lives on a regular basis. Digital technologies were supposed to make us work better and become more efficient.
What, then, is holding back our productive potential? In truth, no single answer exists, and the topic is among the most contentious among economists and other observers.
But a few suspects can be identified in the data. For instance, economies, advanced and emerging, are plowing fewer savings into less investment, as a share of GDP, than they did in the past. Gross fixed capital formation as a percentage of GDP (a measure of total investment spending in the economy) has been declining in the US, Germany, and Japan since the 1970s. In China, which has the distinction of having by far the highest rate of investment in GDP, rates of investment peaked nearly a decade ago and have been dipping ever since.
Slowing investment ought to be worrisome. Productivity is surely multi-faceted, but it nevertheless depends heavily on equipping workers with tools to do their jobs as best they can.
Tepid capital expenditures strike many as an oddity. As noted, today’s is a world of startling innovation. Also, corporate profitability (above all in the US) has sustained levels as a share of GDP not seen in more than a half century. If return on investment is so high, why isn’t there more of it?
One reason may be that too much of today’s innovation serves consumption (pleasure) rather than production (output). We are dazzled by video and audio streaming services, hooked by the proliferation of social media, blown away by virtual reality games, and beguiled by smartphone applications. We pine for the speculative gains of cryptocurrencies and are wowed by electric vehicles. But while those gadgets offer us pleasure, occupy our minds, race our hearts, or even make us feel better about what we are doing for our climate’s heath, they are not enabling workers to produce more with less—the essence of productive investment.
As for high profits, to some extent they reflect increased industry concentration, not more valuable goods & services. Many technologies enable firms to create monopolies or oligopolies defended by high barriers to entry. That leads to recurring outsized profits. But rather than spur new investment, high profits are the visible manifestation of extreme market power and deters entry by new participants.
Low investment might also have demographic causes. If companies invest based on expectations of future revenues, the ageing or even declining population growth will deter them. That may already be a factor in countries with falling populations, such as Japan or Italy, and it may yet be problematic for China.
Lastly, weak investment may follow the slowdown in globalization. For all the talk about ‘reshoring’, the data do not confirm that firms are willing to shift low-cost production in emerging economies into higher cost advanced economies. The loss of investment due to tariffs, wars, geopolitical risk, and the pandemic is greater than the substitution of investment many had predicted.
Apart from weak investment in productive assets, other factors may be behind the puny productivity numbers. Measurement is an issue. Surely, free internet search and access to vast amounts of information create economic value, but are we adequately capturing those benefits in national income accounting statistics? Another hard-to-measure factor is the growing size of services in the economy and our (in)ability to measure output. How well are we healing patients, educating the young, (re)training workers, providing customer experiences? All these endeavors are known challenges for output measurement.
As noted, the major concern associated with weak productivity growth is the stagnation of (average) living standards. But weaker trend growth also implies a slower ‘speed limit’ for the economy. As central banks try to contain inflation by reducing demand, they will have to consider what the productive potential of the economy is to induce enough slack (but not too much) to cool inflation.
In the long run, weak productivity growth is also associated with lower asset returns. Nominal and real interest rates are lower, as is sustainable aggregate profits growth. Risk premia ought to be higher, insofar as weak economies are more prone to shocks, less able to cope with high debt burdens and may exhibit greater political risk.
Paul Krugman once quipped that ‘productivity isn’t everything, but in the long run, it is almost everything’. This week, we are likely to see a plunge in productivity. That news will garner headlines. But the real puzzle is why productivity has been so low for so long. Until America and the world solve the productivity paradox, it will be difficult for people everywhere to realize their dreams and ambitions.