It has practically been an article of faith at the Federal Reserve: Fueled by the Information Revolution, strong productivity growth is here to stay. Indeed, Fed policymakers once again called the underlying growth rate of productivity "robust" as they bumped up interest rates for the fourth time this year on Nov. 10.
But behind the scenes, some Fed policymakers are questioning how much longer the efficiency miracle can go on. They see signs of a slowdown in the torrid pace of technological innovation in the computer and chip industries, advances that have propelled productivity in the last decade. And they wonder if those are a harbinger of less vigorous gains ahead.
After clocking in at a rapid rate of 4.4% in both 2002 and 2003, nonfarm productivity growth slowed to 1.9% in the third quarter. And judging by the 337,000 rise in payrolls in October, it could decelerate further in the fourth, perhaps to as low as a half percent, according to consultants Macroeconomic Advisers LLC.
What's critical is whether this slowdown is symptomatic of a permanent downshift. Most experts aren't too concerned. They see it as only a temporary response to the ups and downs of the business cycle and point to a host of innovations in the tech industry. Indeed, they peg the underlying growth rate of productivity at 2 1/2% or better.
So what exactly is making some Fed worrywarts antsy? Their concerns have been triggered by changing pricing patterns in tech. Between 1992 and 2002, the quality-adjusted price of new computers as compiled by the government fell at an annual rate of 18%. Those sharp dips mainly reflected the pace of technological progress and faster productivity growth. The rapid improvements in technology spurred stepped-up computer buying by businesses, spreading the productivity miracle throughout the economy.
But recently the pace of the price drops has moderated. In 2003 and into '04, computer prices fell at an annual 9% rate. At the same time, business purchases of computers have slowed. "One possible explanation is that we are seeing a deceleration in the pace of technical advancement," Fed Vice-Chairman Roger W. Ferguson Jr. said in an Oct. 26 speech.
Another crunch sign that Ferguson cites: a slowdown in the introduction of PC models. Computer makers roll out models to exploit the latest technological advances in chip speeds. If the pace of such innovation is slowing, there's less need for new computer designs. Data used by the Fed for its industrial production statistics shows that the number of PC models unveiled this year has dropped, perhaps by 10% to 20%.
In sorting out what's going on, some Fed officials point to Intel Corp.'s (INTC ) recent admission that its plan for making microprocessors cheaper and faster hit a wall because its latest generation of chips is too hot to cool efficiently. Intel is shifting to a multiple-core production process that combines processors on one chip.
To be sure, most Fed policymakers, including Chairman Alan Greenspan, are upbeat about the long-term outlook. More important, tech insiders are, too. They say Intel's woes are of its own making and note that Advanced Micro Devices Inc. (AMD ) is well ahead of its rival in rolling out the multicore chips that may become the industry standard.
What's more, tech execs say that they see no signs of a letup of productivity-enhancing innovation elsewhere in the industry that's not necessarily being picked up by government statisticians. Those areas include open-source software as well as wireless and Internet telephony. Amazon.com Inc. (AMZN ) CEO Jeffrey P. Bezos says that disk space and bandwidth costs are dropping by 50% every 12 months, permitting the e-tailer to store ever more content and deliver ever more Web pages to its customers. And like many companies, Amazon slashed costs by switching to the Linux open-source operating system to power its servers.
Economists admit there's much they don't understand about productivity. Yet getting the outlook right will be crucial if the Fed is to successfully steer the economy forward.
By Rich Miller in Washington, with Steve Hamm in New York