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What's the Key to Increasing Productivity Growth Again?

March 29, 2016
Since 2004, U.S. productivity growth rates have fallen below 2% annually. Two recent studies examine the reasons for the troubling trend.

Are we really experiencing a slowdown in productivity? If so, what will it take to change course?

Two newly published studies tackle these perplexing questions. One, a Brookings Institution report co-authored by the Fed’s David Byrne, the San Francisco Fed’s John Fernald and the IMF’s Marshall Reinsdorf, explores the premise that productivity is higher than tracked data suggest. The second report, written by the MAPI Foundation’s Cliff Waldman, examines 25 years of productivity trends in manufacturing by industry and provides insights into the key factors that drive such growth.

Productivity growth, or producing more outputs with fewer inputs, is the key to higher living standards in mature economies. Higher productivity performance allows a country to generate more valuable goods and services per person. When productivity growth lags, living standards stagnate.

Government data suggest that growth has been lagging behind historic averages over the past four decades, except for a surge in the late 1990s. According to the Brookings report, productivity growth between 1978 and 1995 averaged under 2% per year, significantly lower than the rates of the four prior decades. With the rise of the internet and the reorganization of distribution services, the average annual rate jumped to more than 3.5% between 1995 and 2004. Since then we’ve seen average annual productivity rates fall below 2% again.

But some economists and tech entrepreneurs, including Berkeley economist Brad DeLong and Silicon Valley venture capitalist Marc Andreessen, claim that IT hardware, software and services are providing benefits that aren’t captured in standard government data. They use Facebook as an example: federal statisticians attribute $18 billion in economic activities to the web behemoth, but DeLong believes this greatly undervalues a tool that enhances consumer welfare for a billion users.

The Brookings report dismisses such usage as “non-market activities” that save consumers time and increase happiness but don’t have an appreciable impact on national output. Adding to that argument, the University of Chicago’s Chad Syverson points out that estimates of the surplus created by the tech sector in this country fall far short of the $2.7 trillion of “missing output” as a consequence of declining productivity growth.

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Other measures seem to validate lower productivity levels. For example, real median household income is a proxy for living standards. This figure reached its postwar apex in 1999 and has since faltered. According to data from the Federal Reserve Bank of St. Louis, between 1993 and 1999 real median household income climbed 15%, from $50,421 to $57,843. It’s never reached that level again. By 2004, after the collapse of the dot-com bubble and the recession of 2001, real median household income had fallen to $55,565. It climbed to $57,357 just before the Great Recession, then went into free fall. The most recent available data (2014) show a median household income of $53,657.

Another proxy is economic growth. As Meghnad Desai, British economist and chairman of the Official Monetary and Financial Institutions Forum (OMFIF) Advisory Board, has observed, if productivity were actually higher [than current data suggest], economic growth should be higher as well. Especially considering the growth in employment in the United States, if we are indeed underestimating productivity growth, we would be seeing higher economic growth.

What’s the key to increasing productivity rates? Waldman’s study provides some insights. The factory sector has historically enjoyed higher productivity rates than that of the overall economy, but over the past decade its growth has slowed. In his paper, Productivity Dynamics in U.S. Manufacturing, produced in conjunction with Rockwell Automation, Waldman ties this decline to the waning of IT-driven productivity growth (in the computer and electronic products industry) in recent years. While that subsector continues to achieve higher rates than other subsectors, its dominance has fallen—from rates four times those of other leading industries in the 1990s to just a few percentage points higher in the current period.

Waldman’s analysis also shows a distinct link between three key factors and increases and declines in manufacturing productivity growth. His detailed research shows that innovation and capital investment directly correlate to, and thus play a significant role in, productivity growth in a wide range of manufacturing industries. An increase in education levels in the workforce also helps drive productivity growth.

OMFIF’s Desai agrees—innovation is the fix for higher productivity. “We are waiting for the next big explosion of Schumpeterian innovations,” he said. Until then, we won’t return to large productivity growth.

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