The recovery from the financial crisis of 2008-09 brought the slowing pace of aggregate GDP growth into focus, but the fact is that GDP growth has been slowing down for decades, and the rapid growth of the 1990s now appears to be an anomaly.
Demographics play a part in this, as an aging population limits the growth of the labor force, but a major contributor is slower productivity growth. There is no arguing with the facts on the slowdown, and it is tempting to read stories of malaise or complacency into these facts. But we should resist these interpretations, because the productivity slowdown is more a consequence of our incredible ingenuity than a symptom of an inability to innovate.
{mosads}At its core, productivity is a simple concept. It is just output (GDP) divided by a measure of inputs. That measure of inputs could be very simple, like the number of workers. In that case, productivity is just output per worker, and is referred to as “labor productivity”. Or, the measure of inputs could be more complex, combining the number of workers with the stock of capital according to a specific formula. In this case productivity is output per unit of total inputs, called either “multi-factor productivity” (MFP) or “total factor productivity” (TFP) depending on the source.
We care about TFP because labor and capital are costly to provide. Working takes up our time, and providing capital goods requires us to sacrifice consumption today so that we can build houses, make machines, or code software that will generate output tomorrow. Higher TFP means that we are getting more output for our costly inputs, and that allows us to either enjoy more goods and services without having to work any harder, or allows us to work less while still enjoying the same goods and services.
The productivity slowdown is the observation that TFP is growing at a slower rate than it used to. That doesn’t mean TFP is going down, i.e., we are getting less output for our inputs. Rather, it means that TFP isn’t going up quite as fast as it used to. For some reason, it seems harder to increase TFP as fast as we once did.
There is a temptation to equate the productivity slowdown with stagnation in our technological creativity. That is a mistake. Remember, productivity is just output divided by inputs, and thus it includes anything and everything affecting how much output we get for each worker or piece of capital. Technological creativity belongs in there, yes, but it is not the only thing driving productivity.
One of the most important elements of productivity is the distribution of inputs across different sectors in the economy. Some sectors, like retail sales or restaurants, tend to not produce very much output given the inputs they use; they have low productivity. Other sectors, like oil and gas or movie and TV production, tend to produce a lot of output given the inputs they use.
Workers and, to a lesser extent, capital are always moving around between sectors. If workers shift from a high-productivity sector into a low-productivity sector, then this puts a drag on aggregate productivity growth. What we’ve seen in the U.S. over the last five decades is a slow drift of workers out of sectors with high-productivity growth, like manufacturing, into sectors with low-productivity growth, which includes most services.
This reallocation of workers and capital is due in large part to our own preferences. We have a limited demand for most manufactured goods. Bill Gates has an annual income that is more than 20,000 times larger than the average households, but he does not have 20,000 times more cars than the average household, or 20,000 times the TVs or refrigerators of the average household.
While we aren’t all Bill Gates, it is true that, as our incomes rise, we spend a larger and larger fraction of our income on services. To meet the demand for these services, more and more workers get pulled into service work, even though this may not be a high-productivity activity. In manufacturing, automation contributes to this shift of workers. Automation raises productivity, but because of our limited demand for manufactured goods, this means workers get moved out of that sector. This is why technological creativity (AI, robots, etc.) may not translate into observable productivity growth.
The slow productivity growth in the service sector is attributable, in part, to the fact that most services are based on buying people’s time and attention. There is no way to innovate and use less time in many service sectors. There is no way for a security guard to provide eight hours of protection to your business using less than eight hours of time. Major industries like healthcare, education and hospitality all share a focus on time to some degree and so do not exhibit rapid productivity growth.
This shift toward services, and the inherent resistance of services to productivity growth, are not the only reason aggregate productivity growth has slowed down. Concentration within industries limiting competition, slow wage growth limiting the size of the market for new goods, the impact of global trade and perhaps even some reduction in our ability to innovate have all contributed as well.
But even if those other factors did not exist, we would expect to see productivity growth slow down over time as we spend more of our incomes on time-intense services. The slowdown is in part a natural reaction to our incredible wealth, and not just a sign of some pathology in our economy.
Dietrich Vollrath is a professor of economics at the University of Houston, where his research focuses on productivity measurement. He can be found at growthecon.com and on Twitter @DietzVollrath.
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