The Economy -- The Productivity Myth

Dec. 21, 2004
Close examination shows rates are just average.

The decline in real growth from 5.6% last quarter to an estimated 2.5% in the second half of this year will be reflected in a sharp slowdown in productivity gains from recent superheated levels. However, the larger issue is how much of the recent gain in productivity represents better technology, and how much simply represents cyclical patterns where productivity always rises when real growth rises. For excluding a slight upward spike last quarter, productivity growth relative to GDP in recent years has not been appreciably higher than the long-term average. This assertion may appear to fly in the face of "common-sense" logic that the technological revolution has resulted in productivity leaps and bounds; in fact, the true argument is more complicated than that. Rapid growth in technology has been one of the major factors keeping inflation low during full employment. As a result, until recently the Fed did not have to tighten when the unemployment rate fell, which permitted above-average stock market gains and unusually rapid growth in consumer and capital spending. Because of the labor shortage, firms "made do" with existing employees, working them longer hours. Yet since the Bureau of Labor Statistics (BLS) has no way of measuring the length of the workweek for nonproduction workers, this was reported as higher productivity rather than longer hours. Now that real growth has slowed down to 2%, some employees won't work as many hours as previously. However, just as BLS data didn't reflect the rise in hours, it won't reflect the drop in hours, so measured productivity growth will be lower. It should drop to 2% this quarter and next, which isn't terrible, but will represent a major decline from the reported gain of 5.3% over the past four quarters. The best way to measure productivity growth devoid of cyclical influences is from one business-cycle peak to the next. After an initial burst in productivity immediately following World War II, it then rose at an average rate of 2.4% from 1953 through 1979. It then fell to 1.3% per year during the 1980s, and rebounded to 1.9% in the 1990s. One can argue that the slowdown during the 1980s was due to unusually high real interest rates and the large budget deficits. Some will claim this comparison disguises the rapid productivity growth in recent years during the period of declining budget deficits and the emergence of a surplus, but that simply isn't true. Productivity growth in the second half of the 1990s was 2%, almost precisely the same growth as during the first half. Only the figures of the past four quarters have been out of line with historical experience. While we now have a substantial surplus, federal tax rates continue to rise, and will increase further under Al Gore (who I believe will be elected next month). The Aaa corporate bond rate is now above 7.5%, compared with 4.5% during the period of rapid productivity growth during the 1960s, and the real long-term interest rate is 5% now, compared to 3% then. Why are real long-term interest rates two percentage points higher now than in the early 1960s, given the massive and continuing budget surplus? One reason, of course, is the behavior of short-term rates dictated by Fed policy. Before inflation started to rise because of the Vietnam War, the real Fed funds rate was about 2%; now it is about 4%. The same difference is, not surprisingly, reflected in long-term rates. This doesn't mean that Fed Chairman Greenspan is doing the wrong thing. Inflationary expectations are more delicate than they were in the early 1960s. Also, changes in institutional structure mean inflation is more likely to accelerate if the Fed does not remain vigilant. Nonetheless, it should not be surprising that productivity growth now is smaller than in the 1960s, even with the budget surplus, given that real interest rates are 2% higher now. Based on this reasoning, productivity growth is likely to average 2% per year over the upcoming decade. Michael K. Evans is president of the Evans Group and professor of economics at the Kellogg School of Business, Northwestern University, Evanston, Ill.

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