This Missing Ingredient May Foil Hopes for Faster U.S. Growth

  • U.S. investment has gathered pace after years of languishing
  • While productivity may get a bump, innovation still lags

Powell Says Wage Growth Shows Job Market Not 'Excessively Tight'

Robust U.S. investment is fanning hopes that stronger growth in productivity -- the missing piece in the country’s slow-footed economic expansion -- may finally be showing up. Such enthusiasm may be premature.

As Federal Reserve Chairman Jerome Powell outlined in a speech last week, while higher investment is good, there’s a lot more that goes into boosting productivity, making its renaissance much less than a sure thing.

He even repeated precisely what former Fed Chairman Alan Greenspan said more than a decade ago when he warned that productivity growth is “notoriously difficult to predict.”

Productivity describes output per hour of work. If a firm purchases new machinery and pumps out more widgets with the same number of workers, it’s getting more productive.

Its importance to rising living standards is hard to overstate, and its growth goes a long way to explaining the gang-buster U.S. economy in the wake of World War II. From 1948 through 1977, annualized GDP expansion, measured each quarter, averaged 3.9 percent, driven by labor productivity growth that averaged 2.6 percent.

Economists also like to mention a measure that incorporates how efficiently companies use capital, known as total-factor productivity. That averaged 1.9 percent in the same period, according to the San Francisco Fed.

But except for a burst associated with the first Internet boom in the 1990s, productivity growth since the late 1970s has been dismal, especially in the wake of the financial crisis. Labor productivity since 2011 -- when the labor market stabilized after massive layoffs -- has averaged 0.7 percent annual growth, and total-factor productivity just 0.6 percent.

Some of that weakness was surely due to the deep recession and a pullback by firms on investment. So the recent news is good: The amount of money firms plowed back into their companies -- on things like buildings, equipment and intellectual property -- jumped 6.3 percent in 2017 after barely growing at all in 2015 and 2016. That’s the best since 2011.

Operations Upgrades

Companies pour investment dollars into equipment, structures and intellectual property

Source: Bureau of Economic Analysis

Perhaps in response, labor productivity growth ticked up to 1.2 percent in 2017, and TFP to 0.8 percent. That has some in the Trump administration giddy.

“The capital spending boom is going to drive growth up this year, and then the output from all that capital is going to drive up wages and productivity as we go forward,” Kevin Hassett, chairman of the president’s Council of Economic Advisers, told Bloomberg Television in February.

Unfortunately, the relationship between positive swings in investment and larger, lasting upturns in productivity isn’t nearly so neat.

“Periods of rapid productivity growth tend to be correlated with periods of rapid capital accumulation,” says Martin Baily, a former CEA chairman under President Bill Clinton and now senior fellow at the Brookings Institution in Washington. “But one can’t automatically interpret that as a leading indicator. I don’t think there are any good leading indicators.”

Powell, in his speech, noted that investment is only one of three broad inputs to productivity growth, alongside labor quality and innovation. When those components are broken out, it’s clear that variance in investment can make a difference. But most of the gap between high-productivity periods and recent years is due to the lower contribution of innovation.

Productivity Unpacked

Productivity is missing more than just investment

John Fernald, Federal Reserve Bank of San Francisco

Some productivity specialists like Erik Brynjolfsson, a professor at the MIT Sloan School in Cambridge, Massachusetts, are decidedly bullish about the long-term prospects for productivity. He points to promising technological innovations now in the pipeline, from driverless vehicles and voice recognition to health-care diagnostics. But how and when those translate into measurable economic growth, he says, is the real mystery of productivity.

— With assistance by Vince Golle

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