Productivity Growth: The Missing Link?
Spend enough time listening to the financial news or reading economic reports, and you’re bound to come across the topic of productivity growth. This concept, which can be easy to gloss over, plays a critical role in each one of our lives.
That’s because productivity growth is the single most important determinant of a country’s standard of living.
Interview Shifting Landscapes
Defined as the output of goods and services per hour worked, increased productivity allows people to get what they want faster, or to get more of what they want in the same amount of time. At a macro level, these benefits translate into a higher economic output, higher wages, and more leisure time for all.
That’s why many top economists, including those at the Federal Reserve, have been worried about stagnating productivity over the last decade. Fed Chairwoman Janet Yellen recently went so far as to say that the outlook for productivity growth is a “key uncertainty for the US economy.”
Before getting into the factors behind the recent lack of productivity growth, I think it’s important to make sure we understand the importance of productivity at a fundamental level.
Consider the following example:
Suppose an employer hires you to build a 100-foot fence for $1000. Using hand tools (shovel and hammer) it takes you 40 hours to build the fence. This would result in a labor productivity of $25 per hour.
If you had access to better capital goods (power tools), the same project might only take you 20 hours. If that were the case, your labor productivity would rise to $50 per hour.
This would allow you two options: you could work half as much and still enjoy the same amount of consumption, or you could work the same amount and enjoy twice the level of consumption. In either scenario, both your wages and your standard of living would have improved.
There’s another way to slice the benefits of improved productivity that take us deeper down the economic rabbit hole.
As your labor becomes more efficient, it means you can offer to build fences for a lower overall price. By doing this, you begin to share your increased standard of living with others in the economy.
In this case, the benefits of your increased productivity could accrue to a variety of different parties. The company that hired you could become more profitable (the standard of living of the shareholders would improve) or the company could choose to pass along some of those reduced costs to other customers, allowing more people to enjoy the benefits of having a fence.
Regardless of how the benefits of increased productivity accrue amongst different parties (that’s a topic for another day), it can’t be denied that rising productivity helps improve the standard of living in an economy.
As a quick aside, despite all the attention paid to income inequality, changes in income distribution have not been a driver of rising living standards over long periods of time. Rising incomes have historically been the result of rising productivity.
Now that we’re clear on why productivity growth is such an important factor, let’s examine where the US economy stands on this all-important front.
To begin, take a look at this chart (courtesy of the WSJ), which shows annualized productivity growth by quarter going back to the mid-1970’s.
Notice that aside from a few spikes, the growth rate of labor productivity has been falling since the early to mid-2000’s. And almost a decade after the great recession, productivity growth currently sits near its lowest level in over three decades.
This has many economists worried because the elements of the current malaise we find ourselves in (low GDP growth, low wage growth, and low inflation) may all be due to nearly-absent productivity growth.
So what’s causing the slowdown? Well … that’s the trillion dollar question.
Without a doubt, you noticed from our example that technology plays a key role in productivity growth. Having power tools as opposed to hand tools makes all the difference in the world when it comes to building fences.
It should come as no surprise then to see the spike in the chart above during the early 2000’s when the technology boom was in full swing. But what’s happened since then? And is this a long-term or a temporary post-crisis problem?
When asked about the causes of flatlining productivity growth, responses from economists tend to come in two distinct camps. About half of economists point to structural issues (such as an aging population), while the other half cite cyclical causes, such as weak demand.
Those who cite cyclical issues as the dominant factor typically point to charts such as the one below, which suggest the productivity slowdown is primarily a feature of this current expansion.
But while that may be the case, it does not preclude the possibility that the causes are still structural in nature, but have only become evident during this most recent cycle.
Interestingly, there are two distinct areas that both camps tend to agree are problematic: business capital spending and government policy (regulation).
One unique aspect of productivity growth is that it requires periods of underconsumption. In order to produce goods and services at a higher level of efficiency, producers (companies) must devote less energy toward producing products and more energy toward capital projects. The investment in these new projects is what will ultimately drive the new technologies and processes that allow worker productivity to improve.
This post-recession period has been marked by poor business investment and perhaps that’s one reason why productivity growth has been so low. The other cause cited, increased government regulation, plays right into this same scenario.
Any hoop that a company or organization must jump through in order to legally operate their business results in extra labor costs. These costs drive down worker productivity and result in additional manpower being used for compliance purposes, rather than innovation.
While it’s difficult to argue with either of these factors as restraints on productivity growth, there are other explanations that suggest the slowdown is not simply a feature of this particular business cycle.
John Fernald, a senior research advisor at the Federal Reserve Bank of San Francisco, believes that a fundamental shift in the path of innovation lies at the heart of the problem.
He uses the following chart to demonstrate that the drop in productivity growth did not occur in the wake of the great recession but instead represents a secular shift that began shortly after the tech boom.
According to Mr. Fernald, the focus of today’s innovation is on improving leisure time, rather than business efficiency. He also notes the slowdown in the growth of the labor force and plateauing educational attainment as key issues.
Still, others suggest that perhaps technological innovation has simply become more evolutionary, rather than revolutionary. Proponents of this line of reasoning point to the lack of key innovations such as electricity, interstate highways or the internet, which all drastically boosted efficiencies.
But regardless of what the true cause is, the fact remains that without gains in productivity, our economy may be stuck in a low-growth mode for quite a while. Absent a boost in productivity (which the bulk of economists do not expect) it’s unlikely we’ll experience anything significantly above 2% growth for the foreseeable future.
The preceding content was an excerpt from Dow Theory Letters. To receive their daily updates and research, click here to subscribe.
About Matthew Kerkhoff
Matthew Kerkhoff Archive
|04/04/2017||Why the “Trump Rally” Is Nothing But a Bunch of Fake News||story|
|03/28/2017||A Change in the Wind||story|
|03/14/2017||A Look at the Yield Curve and Why the Fed Is Raising Rates||story|
|02/22/2017||Global LEIs and Technicals Point Up||story|
|02/14/2017||Why Global GDP Is Converging Towards 1%||story|
|01/19/2017||Secular Shift in Interest Rates?||story|
|01/04/2017||Key Themes for 2017: Earnings, the Dollar, Tax Cuts and Stimulus||story|
|12/06/2016||Boom and Bust||story|
|11/29/2016||Bullish Confirmations and the Primary Trend||story|
|11/08/2016||Beware of a Trump Surprise||story|