Productivity should be on the next president’s agenda

Slowing productivity is something economists have been concerned about, but it’s hard to pinpoint why it’s happening and how to rev it up.  The next president can put policies in place to give it a kick-start.

Productivity growth is the most important determinant of the growth in average wages and living standards over the long run.  The simplest measure of productivity is output per hour worked (labor productivity) and it has increased at only 1.3 percent a year from 2004 through 2015, in contrast to the pace of 3.2 percent a year from 1995 to 2004.  Weakness in productivity growth, together with an aging population, will lead to stagnant or declining incomes for many Americans.  Why is growth so slow and what can be done about the problem?

One explanation for the slow growth in productivity in the United States is that the engine of innovation has been exhausted.  Northwestern University Professor Robert J. Gordon has made this case in his book The Rise and Fall of American Growth in which he documents the massive changes that have taken place since the start of the industrial revolution, including the introduction of steam power, electricity, mass production, and the great improvements in health.  In Gordon’s view, the computer revolution was the last of the great innovations and its contribution to productivity growth is now over.

The picture of an American economy without major innovations seems wrong to many.  Advances in fracking allowed U.S. oil production to double in just a few years.  In their June 2015 issue Fortune magazine reported a survey of their Fortune-500 CEOs which asked what were the greatest challenges they faced.  The top challenge, cited by 70 percent of the CEOs, was the rapid pace of technological change.  Advances in materials science and biotechnology are just beginning to have a major impact.  Manufacturing companies see productivity gains to be found in robotics, 3-D printing and the internet of things.  So there are exciting technological advances being made, but they are not showing up in the productivity numbers.  Why not?

It may be simply a matter of time.  Perhaps there is a lull in productivity as the latest round of innovations is absorbed and translated into more efficient production.  It would not be the first time this has happened.  The first computers were developed soon after World War II but it took many years before they became cheap enough for routine uses and before companies figured out how to transform their businesses to take advantage of the new technology.  There is recent evidence to support this view coming from research into individual companies.  The gap between the most productive companies in an industry and the rest of the companies in that group has widened.  Some companies have been able to adopt new technologies and push up their productivity, but most companies have not, holding down average productivity.  With time, the laggards should learn to improve and catch up, or else they will be forced out of business.

Another factor in understanding slow growth is the problem of measurement.  Our economy is increasingly made up of services, including such large sectors as health care and education, where productivity growth is not being captured in our statistics.  Major advances have been made in the health care sector, such as new scanning technology, new pharmaceuticals, new medical devices and new surgical procedures, but we do not know whether or not health care productivity has improved as a result.  These measurement problems existed in previous time periods when recorded growth was faster, so it is hard to blame the recent slowing of growth just on measurement.  Still, the more our economy becomes a service economy, the worse the measurement problem becomes.

Despite its importance to the economy, productivity rarely gets mentioned in the policy debate and has been completely absent in this presidential campaign, in part because it is a complex issue not easily understood and a problem that is hard to solve.  But the next president should turn her/his attention to it.

Despite its importance to the economy, productivity rarely gets mentioned in the policy debate and has been completely absent in this presidential campaign.

Productivity growth would be stronger if businesses were investing more in capital: equipment, structures, R&D and software.  Companies will invest where they see profits from doing so, and at present they do not see sufficient gains.  In part, this may be a chicken and egg problem.  A slow-growing economy means companies have enough capacity without making big investments but if everyone invested more, the economy would grow faster.  CEOs also argue that regulation has become more burdensome and that the corporate tax rate is much higher here than in other countries.  The next president should scrub our regulations to make them more streamlined and efficient.  And he/she should reform our corporate tax system, which discourages investment while generating very modest tax revenues.

Productivity growth would be stronger if the workforce were more skilled.  Workers complain they cannot find good jobs while companies complain they cannot find enough skilled workers and both sides are correct.  Young people do not see the payoff from what they are taught in our K-12 system and end up feeling like failures after taking exams.  They spend hours on their phones but, ironically, not enough time mastering new technologies.  Companies are reluctant to train workers because it is expensive and, once the training is complete, many workers quit or move to a competitor.  There is no easy technology fix but new teaching tools can make a difference.  The armed forces train recruits to use complex technologies using short, focused, computer-based courses.  With the right programs, students can move at their own pace and master the basics before going on to more advanced topics.  The next president has limited direct power in this area but can and must use her or his bully pulpit to preach the necessity of addressing the skills problem.  It will take the combined forces of state and local government, businesses, academia, and the federal government to solve the problem.

Companies need the spur of competitive forces to make them change their methods and become more productive.  Antitrust laws are important in making sure that large incumbent firms do not prevent young companies from expanding.  The best companies in the world should be able to set up shop in America, just as American companies have traditionally spread best practices around the world.  Despite its problems, America still has one of the most productive and innovative economies in the world and benefits from global competition.

Companies need the spur of competitive forces to make them change their methods and become more productive.

The US is not alone in facing the problem since almost all the advanced economies have seen declining productivity growth.  But American families expect that children will do better than their parents economically, and that will only happen if a path can be found to stronger productivity growth.