Productivity Growth in the US ... Slipping?
While most people are looking at the US subprime mortgage market at the moment for signs that the impending credit crunch in this sector is likely (or not?) to turn into a systemic shock to the US economy and thus lead to a recession, we also just had a productivity release which was given comparatively little attention at least in terms of the day-to-day jungle drums around the markets. In terms of the facts of the productivity release Mark Thoma had a very to the point entry ...
Revised productivity figures were released today. The revisions were driven by a large upward revision in labor hours. This had two effects. First, with hours revised upward, output per hour - our measure of productivity - declines. Second, with a decline in productivity, unit labor costs increase. Thus, the other side of this is that with higher labor costs, output prices are more likely to be reset upward.
The general decline in productivity changes in recent years is notable (and an impediment for those promoting tax cuts as a means of stimulating productivity growth). Will the series level off at, or just under 2%?
So, there you have it ... a notable slowdown in US producitivity in recent years. I won't go much into the data crunching here since it would really be a 'me too' exercise relatively the already substantial commentaries on this release around the blogs as you will see by stopping by Mark Thoma's entry linked above. A notable addition however would be to include this short post by Dean Baker in which he also summarizes the situation ...
The net result is that productivity growth has averaged just 1.5 percent annually over the last two and a half years. At the least, this is a very serious cyclical slowdown, if it does not actually mark the end of the 1995 productivity upturn.
Indeed, and let us forget for a moment the idea (and implications of the fact fact) that productivity growth should be measured in cycles this does seem to be a somewhat prolonged downturn in US productivity and of course this raises questions for the long term growth rate in the US. This brings me to my actual impetus for this entry namely a recent column in BusinessWeek by Michael Mandel who is also blogging over at Economics Unbound where he has a brief pointer up today on his article. Following my intro above, which is of course a rip-off of Mandel from my side, Michael also seems to worry more about productivity than an impending potential crash in the housing market driven by the subprime mortgate credit crunch.
Consider the facts. Since 1995, when the New Economy and the information revolution really took hold, gains in productivity (output per hour) have averaged about 2.7% per year. That's a full percentage point higher than the preceding two decades.
Faster productivity growth means that the annual output of the economy today is about 10%, or $1.2 trillion, bigger than it would have been at the previous anemic pace. That additional output is more than enough to pay for the war in Iraq, which is costing $100 billion to $150 billion per year, and for the entire $767 billion annual cost of home construction and renovation in 2006. And you'd still have some spare billions left over.
But the bonanza starts to disappear if productivity growth drops much further below its current level. Such a decline is a lot more possible than most economists realize or are willing to accept. History shows that shifts in the long-term trends of productivity are essentially unpredictable. No economic forecaster, as far as I know, foretold the productivity acceleration of the mid-1990s. And nobody, but nobody, predicted the productivity slowdown of the 1970s, which ignited years of high inflation.
What are the warning signs that the productivity revolution might be flagging? One is the decline in business investment in the fourth quarter of 2006, combined with the drop in new orders for nondefense, non-aircraft capital goods in January. This could be due to the housing slump, or it could be that companies are seeing fewer good investment opportunities, at least in the U.S.
Another disturbing indicator would be an unexpectedly high increase in jobs over the next few months. If companies run into productivity problems, their first response will be to hire more workers to meet demand. Finally, the biggest red flag would be a shortfall in corporate profits that lasts more than one quarter, just as a precursor to the New Economy was a sharp rise in profits.
I have no crystal ball when it comes to productivity; no one does. But when you hear that tractor-trailer blow its air horn, it's a good idea to pay attention.
There are of course some questions which seem imminently pressing at this point. First off we have the question whether Mandel is actually right in his claim that we should be more worried about downtrending growth in productivity than a credit crunch in the subprime mortgage market. In my opinion there is a clear bias here in Mandel's view towards taking a long term view at a structural trend as oppose tolookin at the risk of a short term severe slowdown (recession) caused by a systemic reaction in financial markets to the housing bust. However, these two things are of course not totally disrelated in the sense that a structural downtrend in productivity growth will make all the more difficult and crucially it will take more time for the US to claw back if and when a recession occurs.
Turning to more fundamental issues, another question would simply be to ask how productivity is created in an economy and following this how to secure a structurally high growth in productivity over time. Another question which is essentially diagnostic in nature would also query as to the actual reasons to why productivity seems to be falling in the US right at this particular moment? Now, if had a decisive answer to these questions which was proven and tested in the empirical economics lab of the world the Nobel comittee might as well call off the hunt for this year's winner of the prize in Economics I think which of course is merely to demonstrate the magnitude of the issue in determining how productivity is created on a long term basis as a contributor to economic growth and as Michael Mandel also notes ... no economist has ever been able to forecast long term trends in productivity growth.
I will leave the discussion here pointing to some sources I have found very usefull in terms of studying productivity. As regards to the productivity issue in the US I hope I will be able to return to this at another point. Especially, the point about lacking/decreasing investment made by Mandel is interesting I think and is also elaborated by Richard Berner over at MS in the recent GEF brief. Regarding the actual sources of economic growth and productivity this note by Mark Thoma on a piece by David Warsh should provide a good appetizer.
Finishing with some ressources on productivity ...
This paper by Mark Cassidy is written in the context of productvity trends and issues in Ireland. This should not deter you though since the paper also includes a nice comprehensive explanation of what we could call the 'textbook' defintion of productivity and TFP (total factor productivity).
On a more technical and specific note Mark Thoma also had an entry recently which presents an article from the New York Fed by James A. Kahn and Robert W. Rich which takes on the task of tracking productivity in 'real time.' As Mark also notes in his entry the is pretty technical but definitely worth a look if you have to dig into applied productivty studies.
In a most general sense you should also note this paper from the BIS by Les Skoczylas and Bruno Tissot which reviews productivity performance across OECD countries. This paper is definitely worth a look in a general sense to get updated on the 'data' so to speak.
Finally, I am going to end with a goldmine of ressources thanks an entry by New Economist about the fairly recent OECD Workshop on Productivity Analysis and Measurement. The papers and references in New Economist's entry should provide plenty of inspiration and reading on productivity for some time.