The End of the United States Productivity Miracle?

02/08/2007 12:00am

Dean Baker
The Hankyoreh (South Korea), February 8, 2007

As the whole world knows, productivity growth in the United States took off in the mid-90s. After having grown at just a 1.5 percent annual rate between 1973 and 1995, the annual rate of productivity growth jumped to 2.5 percent 1995. Productivity growth increased even more in the current decade, exceeding a 3 percent annual pace in the first years of the new century.

This productivity surge separated the United States from other wealthy countries. In the 70s, 80s, and first half of the 90s, productivity growth in the United States had lagged behind growth in Japan and West Europe. Many economists and policy figures in the United States looked to the practices in these countries for ideas to reinvigorate productivity growth in the United States.

This pattern was quickly reversed with the 1995 productivity upturn. Suddenly, the United States was touted as the economic model for the world, with Europe and Japan being derided for their sclerotic systems. The free-wheeling atmosphere of Silicon Valley, where new tech firms could quickly grow into multi-billion dollar businesses, was the model that the world was told to emulate.

The United States could also boast of a labor market that was largely free of the encumbrances of the European and Japanese systems. Unions in the private sector are rare. Workers can generally be transferred or dismissed with little warning by their employers, and with little interference from the government. Companies can also set and change work schedules in ways that maximize their flexibility (albeit at the loss of flexibility for their workers).

Some of the high-tech entrepreneurs became incredibly rich, even while typical workers experienced only limited gains from the productivity surge. This inequality was also part of the model. In the new high-tech world, some workers have the skills to succeed, while those who don’t get left behind. Governments can try to promote the broader development of skills, but efforts to stem the growing gap between winners and losers would only lead to European type stagnation, or so the world was told.

Well, the basis for the story of the U.S. economic miracle may be coming to an end. New government data show that productivity in the United States grew just 2.1 percent in 2006. The new data bring the average annual growth rate over the last three years to around 2.0 percent. This is still somewhat faster than the 1.5 percent growth rate during the long productivity slump from 1973-95, but it is below the late 90s growth rate, and well below the 3.0 percent growth rates of the first years of this decade. In fact, after adjusting for some measurement issues, the 2.0 percent productivity growth rate of the last three years is about the same as the productivity growth rate across Western Europe. The era of the U.S. productivity miracle appears to be over.

The possible end of the U.S. productivity boom is important for two reasons. First, soaring productivity growth was the key selling point of the U.S. model. Economists rightly place a very high value on productivity growth. In the long-term it is the main determinant of living standards. If a particular economic model can consistently lead to extraordinary gains in productivity, then it may worth tolerating its unappealing aspects. In other words, if a single-minded focus on the bottom line in the United States, with few protections for workers, leads to large and sustained gains in productivity growth, then the model deserves to at least be considered seriously, in spite of its unpleasant aspects. However, if it turns out that the model cannot sustain rapid productivity growth over the long-run, the warts deserve very close examination.

The other reason that the recent slowdown in U.S. productivity growth is so important, is specific to countries like South Korea that are contemplating a new trade pact with the United States. How much South Korea can hope to benefit from such a pact will depend in part on how rapidly the U.S. economy grows in the future. If U.S. productivity growth remains at the lower level of the last three years, then economic growth in the United States will be considerably slower than many economists had expected. With our huge baby boom generation beginning to retire in large number in just a few years, U.S. economic growth over the long-term will average just over 2.0 percent annually, if productivity growth stays at its recent rate. With near-term growth clouded by the prospect of a collapsing housing bubble, it does not look as though South Korea will be hitching itself to a very dynamic trading partner.

Of course, it is still too early to know for sure that the productivity boom is over. The slowdown back in 1973 caught virtually everyone by surprise and was not widely accepted as being a new trend until the end of the decade. Similarly, almost no one saw the 1995 upturn coming, and economists (myself included) took several years to recognize this faster trend rate of growth. So, we have been surprised in the past about changes in the rate of productivity growth. But there is enough evidence on the table at this point to start asking whether the U.S. productivity boom is now over and then start asking some more fundamental questions about how we want to structure our economies and our societies.

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