Nobel prize winning economist Paul Krugman once famously said “productivity isn’t everything, but in the long run it is almost everything.” Economic productivity, or output per unit of input, plays an important role in a society’s ability to raise its standard of living over time. For most of the past 45 years productivity growth in the United States and other advanced economies has slowed. However, the pandemic’s unprecedented impact on economic activity has indicated the potential for a reversal of that trend and increased productivity in the United States. It remains unclear if these indications are meaningful and durable, or if fluctuations are cyclical and temporary. The answer will significantly impact the US economy’s long-term outlook.
Productivity growth is a significant driver of GDP growth and heavily impacts workers well-being. When an economy increases its output without increasing inputs, its people can consume and earn more without paying or working more. Increased productivity also helps prevent inflationary pressures. Though increasing the number of hours worked or the amount of people working can also increase growth, continued long-term growth requires increased productivity within given limits on hours and people.
Increased productivity might occur because workers gain skills or education (human capital), or because workers obtain more effective equipment (physical capital). Economists also refer to total factor productivity (TFP), which is defined as the portion of productivity that is not directly attributed to capital accumulation and reflects other dynamics, such as technological or managerial innovation. In the United States, a common measure of productivity is labor productivity, which is the real (inflation adjusted) output per hour worked, reported by the US Department of Labor’s Bureau of Labor Statistics (BLS).
In the boom times following World War II from 1948-1973, productivity grew at a 2.8 percent annual rate and TFP, reflecting modern innovations, accounted for over half of the growth. Productivity growth helped drive the 3 percent annual real income growth for the median American family during this time. Incomes doubled once every 23 years, approximately once a generation. Amidst the seemingly rapid technological transformations of the digital age, productivity growth since the early 1970’s has been significantly weaker, excluding the period from 1995-2004 when the advent of the internet turbocharged productivity. Real median family income growth has also slowed significantly since the early 1970’s for a variety of reasons, including low productivity growth.
Experts have debated the cause of the productivity growth slowdown in the United States. To date there is not definitive evidence for any one reason and similar trends have played out across many other advanced economies. Several drivers are often suggested, such as fewer transformational and obtainable innovations as compared to the mid-20th century, decreased market competition and business dynamism, slower human capital growth, aging demographics, and lower public investment in R&D and infrastructure. Some also believe productivity growth is higher than reflected in the data. They argue that part of the story is a statistical measurement issue due to difficulty in track digital innovations. However, this seems unlikely to be a primary component of weaker productivity growth.
Since the outbreak of the COVID-19 pandemic in early 2020, US productivity growth data experienced several strong quarterly reports, until the latest reading for the third quarter of 2021 that was the lowest in over 60 years. The last report likely reflected disruptions in the economic recovery from when the Delta variant emerged and slowed activity as COVID cases rose sharply compared to the second quarter. Regardless of these factors, productivity data is often volatile in the immediate recovery after a recession due to cyclical composition effects. In contractionary situations, struggling businesses sometimes let the least productive workers go first and keep just enough workers to survive. Once demand and business activity returns, there is a temporary boost in productivity growth before employment meaningfully expands again during the initial stages of a recovery.
Despite this pattern, there is basis to think that the nature of the pandemic recovery could lead to continued increases in productivity growth. The pandemic altered the way many businesses and workers operate. Some aspects of these disruptions could lead to lasting changes that would boost productivity. Surveys suggest businesses are increasing and accelerating investment in new technologies and operational efficiency methods. Academic research finds that flexible working arrangements including more work from home time increase productivity as a result of time saved commuting, and consumers are relying on digital spending methods that lower business costs at a faster clip.
Over the course of the pandemic some data has supported this story. Capital expenditures by businesses on equipment and intellectual property rights are in one of the strongest cycles in decades according to Morgan Stanley, as evidenced by overall business investment and quickly growing orders of capital goods.
Additionally, the bipartisan infrastructure legislation signed into law and President Biden’s Build Back Better proposals working their way through Congress are expected to increase productivity growth. They contain the highest level of physical and human capital investment the government has made in decades.
The path for US productivity growth in the years ahead is uncertain. Even if it does increase, it will be important to ensure that the gains are dispersed to workers through higher wages and a growing economy, and not concentrated in a small collection of larger firms. How productivity growth unfolds will dictate much of the US economy’s future strength. Enhanced productivity would improve American’s living standards while positioning the US economy to meet future challenges such as climate change, public health threats, and geopolitical competition.
Jeff Goldstein is a contributor to the Atlantic Council’s GeoEconomics Center. During the Obama administration he served as the Deputy Chief of Staff and Special Assistant to the Chairman of the White House Council of Economic Advisers. He also worked at the Peterson Institute for International Economics. Views and opinions expressed are strictly his own.