Productivity And The Economy: Where Has It All Gone?

Productivity And The Economy: Where Has It All Gone?
When Chuck, Chris and I have a question about how something really works, or at least how it’s supposed to work, we often call on Lisa Gladson. A colleague and friend for over 30 years, Lisa holds back on nothing, showing us those few instances where we have it right and the many others where we clearly demonstrate we have no clue. We know she’s right, so it’s great when we have a chance to get together.

Last summer, I asked Lisa to send analysis on topics of interest when it strikes her. Here’s the first one she has sent, which I am honored to share with you.

Take it away, Lisa…

Labor Productivity vs. Marginal Productivity
I have been intending to write this piece for months, but I’ve been very busy. Everyone, it seems, is busier than ever, yet we don’t seem to have much to show for our efforts. The official measure of busy and results – labor productivity – captures the amount of output produced per hour of labor. Based on conversations with friends, family and co-workers, this number should be super high because we are all so busy. Except, it’s not.

In order to understand how different forces affect productivity, it is helpful to think about it in terms of additional workers rather than additional hours. In this context, the additional output created by one additional worker is known as “marginal productivity.” Thinking in terms of marginal units of anything is informative because it allows us to decide whether or not to go forward with a decision. The employer needs to know how much output the additional worker will provide to the firm – the worker’s marginal productivity – in order to make a sound hiring decision.

An interesting feature of marginal productivity is that it will become a decreasing function when everything else is held constant and only the amount of labor is changing. That is, diminishing returns will eventually set in. For example, if an employer continues to hire workers without increasing the number of machines available to the workers, the output produced by each newly hired worker will be less than the previously hired worker. I once explained this concept to a student who worked part-time in a sandwich shop. Visualizing two workers simultaneously using the same meat slicer really drove this point home! This inverse relationship between the amount of labor and the marginal productivity of labor is important to keep in mind because it helps explain the short run variability of worker productivity.

Another interesting feature of labor productivity is that it is enhanced with tools and technology. As the meat slicer example nicely illustrates, a worker in a sandwich shop is able to make more sandwiches using an electric meat slicer than that same worker would be able to do using a dull knife. Similarly, a little technology, like organizing the work area to follow the flow of sandwich making, can also increase worker productivity. We will refer back to the important role played by machines and technology when we try to explain recent trends in worker productivity.

Here is a look at the percentage change in worker productivity from the nonfarm business sector.

The entire time series indicates that the average rate of productivity growth in the nonfarm business sector since 1947 is 2.2%.1 Remember the 1990s and how they felt exceptional? It turns out they were just average in terms of productivity. Everything is relative. Another take away might be that the most recent period looks a lot like the 1980s. However, looking at recent productivity data shows that the latest statistics would look much worse than the 1980s were if not for 2008 and 2009.2 Here, productivity grew at a rate of 3.2% and 3.3%, respectively. This is what happens when the amount of labor decreases dramatically as it did in those two years. Recall, the amount of labor and the marginal productivity of labor move in opposite directions. When your office mate is laid off, the work doesn’t go away, it just moves to your desk. Without 2008 and 2009, the average change in productivity from 2007 to 2015 would have been a tepid 0.5%.3

Economists are feverishly attempting to understand the changes crystallized in this data. The theoretical explanations for decreasing growth rates in worker productivity tend to fall broadly into the following categories: stagnation of technology, lack of investment, and demography.

Stagnating Technology
The main idea here is that new technologies are not as life changing as previous ones and will, therefore, not do as much to increase worker productivity. As Robert Gordon of Northwestern University argues, the U.S. has experienced three distinct industrial revolutions.4 The first, beginning around 1750, which produced steam power and railroad transportation. The second revolution started in 1870 and stretched well into the 1900s. This industrial revolution, according to Gordon, is the source of the really significant gains in productivity. The voluminous list of discoveries in this period includes running water, indoor toilets, electricity and communication systems, to name a few. Gordon also classifies airplanes and interstate highways as spin-off inventions of this time period. Finally, the third period of industrial innovation began in the 1960s and includes computers, the web and mobile devices. While the first two industrial revolutions led to incremental follow-up innovations that were also productivity enhancing, Gordon sees little sign of this in the third revolution. The follow-up inventions make mobile devices smaller and smarter but don’t significantly change worker productivity.

It should be noted that there is plenty of disagreement regarding current innovation and its ability or inability to increase worker productivity. Many economic historians assert that radical innovation, today referred to as disruption, takes time to show up in the data. We have tons of information at our fingertips (literally!), now what do we do with it?

Investment
As stated earlier, a driver of gains in worker productivity is access to tools and technology. Well, it turns out that lots of things fall into this category, including machines, transportation systems, and improvements in health. In fact, anything that makes a human more productive falls into this category. The other commonality here is that all of these things require some form of financial commitment, some view toward the future. Recent analysis from the Brookings Institute indicates that public, non-defense investment spending represented about 1% of gross domestic product (GDP) in the 1960s. That number is closer to 0.06% today.5 A broader measure of investment tells a similar story. Gross fixed capital formation represents both public and private spending on everything from land improvements to equipment purchases to building of schools and hospitals. According to the World Bank, this spending in the U.S. was 19% of GDP in 2013, while the average rate since 1980 is closer to 23%.6 This is occurring at a time of historically low interest rates.

Another important contributor to worker productivity is education. While recent gains have been made in this area, specifically rising high school graduation rates, there is still evidence of stasis. College graduation rates increased at an annual rate of approximately 2% in the 1990s, but only 1% in the first decade of the 2000s.7

Demography
If we think of the human like a machine, an argument can be made that as we age, we start to depreciate. We are still productive, just not as productive as we once were. As the U.S. labor force ages, we should expect to see a decrease in worker productivity associated with this aging. A report by the Bureau of Labor Statistics (BLS) is particularly interesting in that it was published in 1988 in response to data showing a slowdown in worker productivity in the late ‘70s and early ‘80s.8 The look of the report is nostalgic, but it offers a conclusion that a random survey of the current literature seems to corroborate – worker productivity begins to decline after age 45, at least in some industries. The youngest baby boomer will be 53 years old this year. (Can we still call them baby boomers?) According to the December 2015 Employment Survey, workers age 45 and older made up about 44% of the employed portion of the labor force.9

Are we in for a prolonged period of tepid or worse, declining worker productivity? It seems a strong argument can be made for just that. However, can’t a case also be made that says we can see how we got here, so let’s make some changes to mitigate what appears to be inevitable? Maybe Big Data will become the new factor of production that makes everything more efficient. Maybe new metrics incentivize firms and government to increase investment that promotes worker productivity. The baby boomers won’t stop aging, but there is an even larger generation – the millennials – beginning to enter the labor force. I know they are really busy, but maybe a renewed focus on worker productivity means their efforts will show up in the numbers.

Frank again…

A big thank you goes to Lisa Gladson from all of us at EverBank Global Markets Group for her contribution. We’ll look forward to reading more from her in future Daily Pfennig® newsletters.

Onward and upward.

Until the next Daily Pfennig® edition…

Sincerely,
Frank Trotter
EVP & Chairman
EverBank Global Markets Group
1.855.813.8484
everbank.com