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Productivity Growth Now?

Thursday, December 08, 2016

John Lambert, Investment Director at GAM, blows the productivity mismeasurment myth. The future is more hyperbole than hypergrowth.

While writing on productivity might ironically be an inefficient use of time, the subject remains a key influencer to the long-term direction of the global economy. Productivity improvements are the main channel by which per capita income, and hence living standards, can rise. Although many dismiss weak productivity growth figures as a result of mismeasurement due to technological advances, we are not on the cusp of a great injection of productivity growth.

Weak productivity growth, now and always?

Growth rates in measured productivity and incomes in the US have slowed in recent years. Overall economic growth has also been considered 'below par’. This is confounding those more accustomed to the higher rates of the last few decades, but they are suffering from recency bias. For labour productivity, growth in output per hour since the early 1970s has been around the 1.5% pa mark, with the exception of 1995–2004 which was closer to 3% pa. While current rates are undeniably low at under 1.0% pa, it’s the brief golden period at the end of the century that appears to be the anomaly.

But a low-level rate should really be no great surprise: Industry concentration has risen over the last few decades, meaning less competition and more rent-seeking behaviour. No wonder profits have risen as investment rates have declined, resulting in fewer opportunities (and less need) for productivity enhancements. Ultra-low interest rates have only exacerbated this, and companies have engaged in financial engineering instead.

At the small-scale end of the business spectrum, the financial crisis has meant a reluctance by banks to lend to small firms. High rates of employment, weak income growth and low investment rates all triangulate with weak productivity growth.

Measuring misdemeanours

The claim that productivity growth is being mismeasured due to pervasive technology and intangible factors has little merit. A Brookings Institute paper looked at this issue and made the following points.

  • The productivity slowdown has been broad, occurring both in industries that are straightforward to measure, and those that are harder. They found that a decline had occurred in two-thirds of industries since 2004, suggesting mismeasurement is not the problem.
  • The decline in productivity growth cannot be attributed to a changing mix between sectors in the economy either, claiming that even when using sector weights from 1987, the overall picture of a slowdown does not change much.
  • Much of what we think of in terms of technological progress is first, free, and second, actually benefits our leisure time, not our working practices. Consumer surplus might have risen, but there has been minimal impact on output.
  • Acknowledging the challenges in measuring productivity and making price adjustments for quality, the Institute found productivity growth since 1995 had indeed been understated. It also found it was understated to a greater extent between 1995 and 2004 than recently, since domestic production of IT was higher in that period, which makes the slowdown in growth more substantial than the headline data suggests.
If weak productivity growth is not about mismeasurement, how should we connect technological progress?

While technology is constantly progressing there is little sign yet of anything truly transformative. Instead we have seen lots of incremental progress, the ‘world is awash with small discoveries’, according to the US National Academy of Sciences.

The technology sector is quite small, and while gains in productivity at the cutting edge might be considerable and high-profile, the impact on other parts of the economy has weakened productivity. Case in point, the impact of Amazon on offline retail assets. An additional issue is known as ‘Baumol’s cost disease’: sectors with high productivity gains often face more rapid price deflation, shrinking in relation to the wider economy. This leaves other sectors experiencing wage inflation beyond what is justified by their own productivity gains. In that sense they are a victim of their own success.

So while we continue to innovate, albeit in subtle ways on a day-to-day basis, the impact of our progress is less significant for the economy. For now at least, the Third Industrial Age remains more hyperbole than hypergrowth.

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