You want higher income growth and living standards? Hey, who doesn’t. Then your economy needs to be come more productive. more innovative. Again, the de rigueur quote about productivity from Paul Krugman: “Productivity isn’t everything, but in the long run it is almost everything.”
He’s right. But as the above chart shows, US productivity is barely growing. A second great productivity slowdown. Actually more like a collapse. If you are making the Great Stagnation case, this chart is pretty persuasive about a lack of US innovation.
If you believe the chart. And Goldman Sachs has its doubts, as it again explains in a new report. I have blogged before about this analysis (and the debate surrounding it) by the firm’s chief economist, Jan Hatzius. But this is a helpful summary by Hatzius about the digital economy, and why official data likely overstate the productivity and innovation slowdown:
(1) A spurious slowdown in IT hardware deflation. An important recent study argues that much of the slowdown in measured semiconductor deflation since the early 2000s may reflect changes in industry structure, not a true slowdown in technological progress; similar issues may affect computer price measurement Further, the shift in US technology output from general-purpose products such as semiconductors and computers toward harder-to-measure special-purpose products such as navigational, measuring, electromedical, and control instruments may also have increased measurement error.
(2) An increased GDP share of IT software and digital content. Measured prices in the software and digital products industries have been broadly flat for many years. One stark example is internet access. The official price index is basically flat, simply because the typical user still pays roughly the same monthly dollar amount for home internet access. There is no adjustment for the big increases in connection speeds or the availability of free internet access outside the home, let alone the fact that the expansion in online content makes “an hour of internet access” a much better product than it was a decade ago. This suggests that the true quality-adjusted price of internet access has been falling sharply. If this is a widespread problem in software and digital content, as we believe, the growing share of these industries in the economy has led to a growing understatement of real GDP and productivity growth.
(3) An increase in “new product bias” because of the proliferation of free digital products. Price indices do not always fully capture early-stage price declines and welfare gains associated with new products. Under normal circumstances, this “new product bias” can be minimized by including new products in the price index as soon as possible. But free digital products have no price and are never captured in the CPI, even though they may generate a substantial amount of consumer surplus (internet search is one example).
Our best estimates for the size of each of these biases suggest that IT-related measurement error may be holding down real GDP growth by a sizable amount, with a point estimate of 0.7pp per year now vs. only about 0.2pp in 2000. The corresponding downward bias on measured labor productivity growth in the nonfarm business sector—which accounts for about 75% of GDP—would be slightly larger at about 0.9pp now vs. 0.3pp in 2000. These estimates suggest that an increase in measurement error might explain a sizable share of the slowdown in consensus estimates of the underlying productivity trend from 2½% in the mid-2000s to barely above 1½% now. Our analysis has three main implications.
(1) Let’s not despair. Our best estimate is that there has been some slowdown in productivity growth even after accounting for the potential measurement errors, but it may be far less dramatic than shown in the official data.
(2) Focus on employment, not GDP. Given the uncertainty around GDP, it is better to focus on other indicators to gauge the cumulative progress of the recovery and the remaining amount of slack. Workers are much easier to count than GDP.
(3) Another reason to keep policy accommodative. Our story implies that true inflation is lower than the already-low measured inflation rate. At the margin, this probably reinforces the case for continued accommodative monetary policy.
So instead of a Two Percent Economy, maybe we really have a Three Percent Economy. And calls for 4% GDP growth target suddenly looks more reasonable with better tax, regulatory, education, public investment policy. So productivity and economic growth could be faster — and better distributed — but overall the US still seems pretty awesome.
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