America’s Productivity Problem

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Would you like a raise? How about more vacation? Of course you would. If you’re anything like me, one of your main motivations each day at the office is the prospect of advancing, making more money, or even earning more time off to spend on the things outside your career that matter.

The main factor that makes any of this possible is rising worker productivity. The more efficiently we do our jobs, the more our employers can justify paying us — be it in salary or leisure. And one of the economy’s main weaknesses of late has been a decline in the growth of labor productivity, a dynamic that might help explain the plight of the average American worker in recent years.

On Friday, the Labor Department announced that labor productivity rose at just 0.9% in the second quarter of this year, after falling 1.7% in the first quarter. And these numbers aren’t an anomaly: According to a report issued last week by JPMorgan Chase economists Michael Feroli and Robert Mellman, worker productivity has only grown at an annual rate of 0.7% in the past three years, after averaging 2.9% growth from 1995 to 2005.

And as Feroli and Mellman point out, the decrease in productivity growth began even before the recession, and has coincided with a slowdown in technological growth, as measured by the pace in which computer equipment has become more affordable in recent years. According to the report, “Over the past few years the real price of information-processing equipment and software has declined at the slowest pace in more than a generation.”

(MOREMan vs. Machine)

So why does this change in the pace of technological advance matter? Economists believe one of the main factors that drive worker productivity is technology. As a firm invests in new technologies like new computers, software or high-speed internet, it enables its workers to get jobs done more efficiently. Over the past generation, we have seen an incredible decline in the price of high-tech equipment, which has driven much of our economic growth over that time period — especially during the boom years of the 1990s.

What the most recent numbers regarding prices of IT equipment imply is that the efficiency gains brought by the digital revolution may be petering out, and that will have a direct effect on our ability to become more efficient workers. And if we want to get back to the worker-productivity gains we were experiencing a decade ago, we need to somehow figure out how to encourage the kind of technological innovation that has led to previous waves of sharp productivity growth.

Of course, this raises the age-old question that economists have been arguing over for generations: What causes innovation? Conservative economists tend to believe that innovation is spawned mainly by the ingenuity of entrepreneurs. They rely on what is known as Say’s law, named after the classical economist Jean-Baptiste Say, which states that “supply creates its own demand.” When Steve Jobs designed the iPhone, for instance, there was no demand for the product. It’s creation created the demand for the product, which is now significant. Since the iPhone was launched in 2007, the smartphone market has exploded, and businesses across the world have invested in these products so that their workers can be constantly connected and work more efficiently. In this worldview, the entrepreneur is the instigator of growth, and therefore we must do what we can to avoid dampening his incentive to create.

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But the entrepreneur isn’t the only source of productivity growth. Firms can simply invest more in existing technology, intellectual property, and research and development. And it turns out that growth of this sort of spending has slowed from an average of 4.7% per year in 1980 to 2000, to 2.8% per year over the past 10 years, according to the report.

And when you ask businesses why spending on R&D isn’t growing as quickly as it was in the past, or why business investment in general hasn’t rebounded as it did after past recessions, they say it’s because of a lack of consumer demand. And this is why liberals tend to argue for government stimulus to jolt the economy into what they believe will be a self-sustaining virtuous circle of higher demand and growth — especially during a time when interest rates are so low and therefore the cost of action small.

If you get the feeling there’s a certain familiarity to this argument, you’re right. The debate over why productivity growth has slowed echoes many of the political debates going on right now, with one side stressing the ingenuity of the producer class, while the other emphasizes the health of the consumer class. Ideally, an economy would have a risk-taking entrepreneurial class and a healthy and confident consumer class. Right now we have neither, and we’re not quite sure which ought to come first.