Over-Rated Virtues of High Productivity Growth

August 11, 2009

Productivity, output per employee hour, plays a a key economic role.  The growth of real GDP stems either from gains in hours worked or faster productivity.  Strengthening productivity provides a basis for faster economic growth, better wages, lower inflation, and lower interest rates.  The belief in a fairly enduring advance in productivity was the critical assumption that persuaded former Chairman Greenspan not to raise U.S. interest rates more forcefully in the 1990’s despite irrational investor exuberance and real economic growth at speeds which had historically promoted accelerating inflation.

But is strong productivity enough?  Greenspan was correct about the shift in productivity.  It wasn’t a flash in the pan.  After rising 1.5% per annum in the 1980’s, U.S. productivity accelerated to speeds of 2.0% per annum in the 1990’s, 2.6% per annum over the first nine years of the current decade, and 3.3% annualized in the first half of 2009.  The 6.4% annualized jump last quarter was the highest since 3Q03, and a 1.8% increase between 2Q08 and 2Q09 despite an extraordinarily severe recession was just a shade under the 2.1% per annum average pace during the entire second half of the 20th century.  Historically, periods of recession have been associated with cyclically weak productivity.  Stronger gains in productivity have delivered wage disinflation.  After advancing 6.3% per annum in the 1970’s, U.S. unit labor costs slowed to a pace of 4.2% per annum in the 1980’s, 1.9% per annum in the 1990’s, 1.6% per annum over the first nine years of the present decade and 1.6% per annum in the first half of 2009.  A 0.6% drop of unit labor costs in the year to 2Q09 was the lowest on-year reading since the second quarter of 2000.

From the standpoints of productivity and unit labor cost trends, improvement has continued, and the last 10-15 years have been truly as good as it gets.  But the story did not have a happy ending.  Alas, it’s been an era of global boom, then bust, with a series of financial market breakdowns — the Mexican peso devaluation, the Asian balance of payments crisis, Russia’s default, the bankruptcy of Long-Term Management Capital, the dot.com bust, Japan’s deflation, the sub-prime lending market breakdown, the fall-out of that rupture to many other financial markets, and the Great Recession.  It seems paradoxical that the worst financial market crisis in 100 years and severest world recession since the early 1930’s should coincide with a golden age of U.S. productivity.

The lesson to be inferred is not that strong productivity is a bad thing but rather that such a development is not a panacea, allowing policymakers and regulators to drop their guard and abandon their responsibilities to spot and correct problems before they become to big to fix.  Even when productivity expands strongly, structural imbalances and market excesses can fester.  A second lesson from the global economic train wreck is that policy coordination is more important than ever in a more highly inter-connected world economy.  That doesn’t mean that G-8 or, more appropriately, G-20 officials need to map out and approve one another’s plans.  Each nation has somewhat different circumstances and policy needs.  But it does mean that policymakers should consider international ramifications when crafting policy.  There is a need for greater global responsibility, and it is not entirely altruistic to consider how one’s actions might affect other economies.  What goes around comes around.  Just about every economy was sucked into the Great Recession, proving the fallibility of parochial policy thinking.

Copyright Larry Greenberg 2009.  All rights reserved.  No secondary distribution without express permission.

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