Drop In U.S. Productivity Has Important Implications

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Includes: RINF
by: Kristina Hooper

Productivity directly impacts prosperity

Productivity is an indispensable but often overlooked ingredient when it comes to evaluating economic growth and prosperity. And when searching for reasons why the current recovery is the weakest post-war recovery on record, one cannot look past productivity declines.

Generally, productivity is defined as the ability to generate, create, enhance or bring forth goods and services. However, in economic terms productivity is typically measured as the ratio between output volume and input volume. In other words, it measures how efficiently the key inputs of production, such as labor and capital, are being used to produce a given level of output.

One of the most common measures of productivity is GDP output (excluding government, non-profit and private household outputs) per labor hour. Real GDP is of course an inflation-adjusted measure of the value of all goods and services produced in a given year. This productivity statistic, produced every quarter by the Bureau of Labor Statistics, was released last week for the fourth quarter of 2015. It showed that nonfarm productivity dropped at an annualized rate of 3%. This was worse than expectations - and in fact was the worst quarter for productivity in almost two years.

An age of diminishing expectations?

What's more, we learned that productivity rose only 0.6% for calendar year 2015. This is well below levels we saw a decade ago, and also well below the long-term rate of 2.1% from 1947 to 2015, raising concerns about economic growth going forward. As Paul Krugman explained in The Age of Diminishing Expectations,

Productivity isn't everything, but in the long run it is almost everything. A country's ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.

More specifically, productivity is important because it can lead to higher unit labor costs (employers need to spend more to get the same level of output), which can in turn put pressure on corporate profit margins. And eroding corporate profit margins are typically a precursor to a recession. So productivity is a very important concept right now.

Economists point to many causes of diminished productivity in the United States - and elsewhere in the developed world. The most common reasons given include lower investment activity, lower research and development (R&D) spending, a decline in the number of start-ups post global financial crisis and a decline in education - or at least the quality of education in relevant subjects.

In the US, we've certainly seen all of the factors listed above, most notably a lack of capital investment and a lack of R&D spending, and recognize that all these factors have had a negative impact on productivity. It is also worth noting that emerging markets are not immune from lower productivity growth, although factors impacting productivity there include the maturing of their economies and mis-investment - in other words, investing in areas that aren't as productive.

But before we write the epitaph on US productivity growth, we have to ask whether current measures are able to accurately capture productivity improvements in today's economy. For example, last week I flew to southern Florida to give a presentation at a conference. I was advised to take a taxi to my hotel and was alerted that the cost of such a cab ride would be approximately $50 to $60. Just a few years ago, that's exactly what I would have done. However, instead I used the Uber app on my iPhone to grab a ride - for slightly more than $19. Not only was it easier and faster to get an Uber car, but the cost was far less. So how does this example (one of many) make its way into an improvement in productivity as we currently measure it, particularly since the "value" of the service went down dramatically?

The double-edged sword of technology

Fifteen years ago, when I was home sick, I could barely get any work done. I was accessing the Internet via dial-up over my telephone; needless to say it took a lot of time to do simple tasks such as answer an email. Today I'm accessing the Internet over wifi as quickly as I do in the office, enabling me to answer emails rapidly, in addition to doing so much more.

Similarly, when my husband and I used to go Christmas shopping for our kids, we would drive miles to various malls, chasing down items on each child's list. Now we sit in the comfort of our family room, ordering those items online in a fraction of the time with a fraction of the headaches. And those are just a few examples out of the many ways life has gotten easier and more efficient. In fact, when I stop to think of how technology has improved our well-being and our efficiency, it takes my breath away.

It seems increasingly difficult for traditional measures of productivity to accurately gauge true productivity. However that does not necessarily mean output per worker is actually improving, particularly given the presence of all the factors mentioned above. In addition, technology is a double-edged sword: While it increases the efficiency of US workers, it also increases the number of potential distractions for US workers - just think of Cyber Monday, when so many Americans do holiday shopping on the Internet rather than their work from their office desks. So perhaps technology is part of the reason traditional measures of productivity show a decline.

One more reason for declining productivity could be that, with an unemployment rate of 4.9%, we are running out of qualified workers.

Let's hope that in the future we can find better ways to measure productivity so we can answer these questions more conclusively. In short, understanding productivity and accurately measuring it is critical to predicting future economic growth in the US.