Rising living standards are (pretty much) all about rising productivity. That will be especially true for the US going forward as demographics continue to cause a slowdown in labor force growth. As the New York Fed explains in a new note:
The contribution of labor input to the potential GDP growth rate for the United States has changed over time. We decompose this contribution into two components: the size of the adult population and the average demographically adjusted employment rate. We find that these two components in the late 1960s and early 1970s contributed at least 2.5 percentage points to potential growth. Since the mid-1990s, the aging of the population has reduced the contribution of labor to growth. We estimate that the current contribution to potential economic growth from labor input has declined to around 0.6 percentage points. One implication going forward is that more labor productivity growth will be required to sustain U.S. growth.
An unfortunate reality, given recent US productivity data. As the WSJ notes:
U.S. worker productivity fell in the opening months of 2015, extending a poor track record since the recession and underscoring longer-term risks to American workers’ wages. The productivity of nonfarm workers, measured as the output of goods and services per hour worked, decreased at a 1.9% seasonally adjusted annual rate in the first quarter from the previous period, the Labor Department said Wednesday. … That marked the second consecutive quarter productivity has declined, something that has happened only three times in the past quarter century. The latest dip punctuates a series of sub-par readings since 2010.
A different WSJ piece outlines two Fed views about productivity problems:
By now it is clear that U.S. productivity growth has slowed and an important debate is taking place inside the Fed about exactly when that happened. John Fernald, an economist at the Federal Reserve Bank of San Francisco, in research has argued that the slowdown startedbefore the financial crisis and was associated with the end of the information-technology driven boom of the 1990s. David Wilcox, director of the Federal Reserve Board’s research and statistics division, argued with colleagues in a 2013 paper that the slowdown was associated with the 2007-2009 recession, and a drop-off in new business formation and in productivity-enhancing investment by firms.
The Wilcox story is the more hopeful one. If the productivity slowdown is associated with the recession, then presumably its effects will eventually wear-off and growth can get back on a faster path without causing inflation. The Fernald story is troubling. If productivity was really in a downtrend before the crisis, then Americans might be stuck with an economy prone to serial growth disappointments for the foreseeable future.
And here is JPMorgan’s Michael Feroli:
For the first few years following the crisis, the FOMC persistently forecasted very strong GDP growth, arguably unrealistically strong GDP growth. For example, in late 2009 the midpoint of their 2012 GDP prediction was 4.2% (actual came in at 1.6%). Recently, their GDP projections seem more realistic: the average midpoint over the next three years is 2.4%, not far from the average realized over the past three years, 2.2%. While their GDP forecasts now appear more tempered, the implicit productivity growth embedded in those forecasts has remained very upbeat. As this morning’s productivity report reminded, the productivity outcomes over the past few years have been anything but upbeat. Moreover, the historical case for a late-cycle acceleration in productivity is shaky. Thus we think there is a good chance the Fed’s current optimism on productivity will fare about as well as their past optimism on GDP growth.
… we estimate that the total economy productivity growth rate embedded in the midpoint of the FOMC forecast over the next two years is on average about 1.65%. Due to sectoral differences in coverage, the nonfarm business sector productivity number reported this morning tends to run on average about 0.4%-point faster than total economy productivity growth. So we estimate that the nonfarm business productivity number embedded in the Fed’s forecast is in the neighborhood of 2%.
How realistic is this? Over the last five years nonfarm business productivity has grown at an average annual rate of 0.6%. To get to 2% would require over a tripling of the pace of productivity growth. That may be especially challenging as productivity tends to exhibit a cyclical regularity – growing faster early in the cycle and slowing as the expansion matures. As the table below demonstrates, the only exception to that pattern was the 1990s expansion, when the once-in-a-generation surge in technology led to a late-cycle pickup in productivity growth; even then the acceleration was less than what the Fed is currently implicitly forecasting. In short, the Fed’s productivity forecast seems like a long shot, but that’s what is holding together their interest rate projections.
Economist Michael Mandel offers an interesting perspective on what the productivity numbers mean for the old “growth vs. redistribution” argument:
Based on today’s release from the BLS, ten-year productivity growth has now plunged to 1.4%, the lowest level since the 1980s (see chart below). By comparison, ten-year productivity growth was 2.2% when Bill Clinton left office at the end of 2000, and hit a high of 3% at the end of 2005. Productivity growth is the central force determining the size of the economic pie. Without productivity gains, living standards cannot show a sustainable rise.
Certainly real compensation growth is very weak as well. However, the difference between ten-year productivity growth and ten-year real compensation growth has also been narrowing. It was 1.1 percentage points as of the first quarter of 2015, after peaking at 1.7 percentage points in 2011. That difference of 1.1 percentage points is only slightly above the 50-year average of 0.8 percentage points. To put it a slight different way, real compensation growth has fallen from 1.5% in 2000 to 0.3% today, a catastrophic drop. However, two-thirds of that plunge can be attributed to a drop in productivity growth (from 2.2% to 1.4%), and only one-third to a widening of the gap between productivity and compensation growth. My conclusion: The sharp fall in productivity growth is the major reason why Americans feel so squeezed. Growth policies are key.
Unless of course the numbers are all screwy. (And here, too)
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