Productivity: Is the Boom Over?

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Dean Baker
In These Times, March 15, 2007

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While it may sound like an obscure detail for economics nerds, the Department of Labor's latest data on productivity growth should be causing a greater stir, because it is hugely important for the economy and people's lives.

In the mid-'90s, the rate of productivity growth unexpectedly jumped from 1.5 percent a year to more than 2.5 percent year, where it stayed until the middle of 2004. But since then, the new data show that productivity growth has dropped back down to just a 1.5 percent annual rate. It is too early to pronounce the end of the '90s growth spurt, but it is certainly not too early to be concerned.

Productivity growth is the main long-run determinant of living standards. It measures the value of goods and services produced in an hour of work. If productivity increases rapidly, then workers can enjoy substantial and sustained gains in living standards. This can mean more goods and services (including items like health care and education) and it can also mean more leisure, so that workers can sustain the same living standard even as they work fewer hours. More rapid productivity growth also makes it easier to address problems like global warming, since an economy with rapid productivity growth can more easily divert resources toward reducing greenhouse gas emissions while still raising standards of living.

For these reasons, we should be very concerned about the rate of productivity growth. While distribution is extremely important-at a point in time, more for Bill Gates means less for everyone else-it is a lot easier to accomplish almost any goal (including redistributing income) in the context of rapidly rising productivity.

It would be easier to gauge the course of future productivity growth if economists had a better idea of what caused it. However, the two big changes in productivity growth trends in the post-war period both caught economists by surprise.

In 1973, the rate of productivity growth slowed sharply, after a quarter-century of rapid growth. Even today, there is no widely accepted explanation for this slowdown. And when the economy upturned in 1995, economists also had no explanation. While everyone knows that computers and information technology were central in this boom, computers (even PCs) had been around for decades without having any measurable impact on productivity growth. It is not clear why computers suddenly led to a productivity boom at that time.

Since we don't know what caused the upturn, there is not much basis for saying if and when we should expect the burst of productivity to come to an end. But we can certainly speculate on some factors that could play a role.

At the top of my list is the fast money game being played on Wall Street with hedge funds and other forms of creative finance, which can have negative effects on productivity growth for two reasons. First, economic theory tells us that workers will respond to incentives, which means that many highly educated people are running to careers on Wall Street in pursuit of multi-million dollar paychecks, instead of careers in computers, engineering, medicine and other productive areas. And second, many of the buyouts may be structured primarily with the goal of generating fees for agents rather than creating viable productive companies. We'll know more about how these deals turn out after the next recession, but anyone who thinks that the high-rollers always know what they're doing need only think of Time-Warner. The world's largest media company sold itself for AOL stock at the peak of the Internet bubble. In a couple of years, the AOL stock was almost worthless, which meant that Time-Warner had sold itself for almost nothing.

There are other potential villains on the productivity front. Diverting resources to the military drains them from productive uses. Similarly, our patent financed systems of drug and software development are hugely inefficient. And of course, leaving much of our population poorly educated and locking up more than 2 million people in prison doesn't help productivity either.

Raising productivity growth is not easy, and at this point the data do not yet clearly show that we have a problem. However, the stretch of slow productivity growth has persisted long enough that it should be getting serious attention.


Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (www.conservativenannystate.org). He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues. You can find it at the American Prospect's web site.