The Productivity Problem

It’s a political season, so we’re hearing a lot of the usual arguments the economy. Should we raise taxes or lower them? Negotiate trade agreements or abandon them? These are important questions, but they are not the central economic issue that we face today. Productivity is.

As economist Robert Gordon explains in The Rise and Fall of American Growth, productivity growth soared between 1920 and 1970, but has sputtered since then. What’s more, he predicts that the productivity picture will get even worse in the decades to come, making it even harder to raise living standards.

To be clear, this is not a recent problem, nor can be laid neatly at the feet of one politician or another. It is also not a distinctly American challenge, but a global trend. So rehashing old arguments will get us nowhere. The truth is that the productivity problem is unlike anything we’ve faced in the last century and we’ll have to come up with new solutions for it.

Slowing Innovation While Fighting Headwinds

Try to imagine what life was like before 1920. Few people had cars, indoor plumbing, electricity or higher education. Ordinary chores, such as washing clothes or cooking a meal, required families to carry heavy loads of wood and water. Without refrigeration, food spoiled regularly. Women, consumed with household labor, rarely worked outside the home.

So it’s not surprising that as homes became automated, productivity soared. That’s one reason why Gordon argues that low productivity levels are here to stay. Today, despite some narrow improvements in areas like digital technology and entertainment, life hasn’t changed much since the 1970’s. Education levels are also unlikely to raise much from present levels.

But that’s not all. At the same time that innovation has slowed, Gordon argues that there are six headwinds — namely demography, education, inequality, globalization, climate change and the overhang of consumer and government debt — that will be barriers to faster growth. To understand his point, let’s look at just a few of them in combination.

As the baby boomers retire, the growth of the working force slows and the increase in retirees rises. At the same time the leveling off of the rate at which people attain higher education, combined with supply side pressures from globalization and higher levels of both public and private debt will make for a smaller economic base from which to finance retirement.

Former Treasury Secretary Larry Summers argues that the confluence of these factors leads to secular stagnation, an economic condition that features excess saving and diminished investment, demand and economic prosperity.

Bill Gates’ Barber And The Baumol Effect

Another factor dragging down productivity is the composition of the economy. Since the 1950’s, manufacturing has fallen from about 35% of the labor force in the US to about 20%, while at the same time services has soared from just over half of the labor force to nearly 80%. That’s a dramatic shift.

To understand how this affects productivity, think about Bill Gates and his barber. Over the last 30 years, technology has gotten thousands of times more powerful, making people like Bill Gates far more productive. His barber, on the other hand, still cuts only one person’s hair at a time. Still, because Bill Gates has gotten richer, the price of haircuts has gone up.

This is known as the Baumol effect and it is having a measurable impact on industries, like healthcare and education, that depend on highly skilled professionals to provide service. Not coincidently, costs in both these sectors of the economy have ballooned over the past few decades without a corresponding increase in productivity.

So instead of spending more money on things that will improve our quality of life, an increasing portion of American incomes are going to things like health insurance premiums and paying down student loans.

Technology Tipping Points?

The seeds for the transformation that took place in the 1920’s were actually sown long before. Edison opened the first electrical power plan in the US, Pearl Street Station, in 1882 and Faraday invented the dynamo 50 years before that. The internal combustion engine was invented in 1876 and Henry Ford introduced the Model T in 1908.

So it’s not quite clear whether innovation has hit a wall or is merely in hiatus. Gordon argues, accurately, that the impact of digital technology has been narrow, but there are indications that we just haven’t seen its full effect yet. To be sure, it’s begun to power new technologies, such as genomics, nanotechnology and robotics, that may be far more pervasive.

To understand the impact that these technologies can have, consider the case of solar energy,which relies on nanotechnology. Since 2009, the price of solar panels has dropped by 70%. That’s made them competitive with fossil fuels, but not transformative. Now consider the fact that solar efficiency improves by about 20% for every doubling of volume and you can see the potential for the future.

It’s not just solar panels either. The same trends hold for a variety of exciting new technologies, such as energy storage and genetic sequencing. Advances in artificial intelligence also have the potential to automate many service jobs. To take just one example, 2000 cases of beer were recently delivered by a self-driving truck.

Unfortunately, we won’t see the true impact of these new technologies till after 2020. So until then, we will just have to wait and see. But we can certainly improve our odds by investing in research that will make the advances we need more likely to happen.

Shifting The Debate

Consider the facts laid out above and it should be clear how irrelevant the political debate around economics has become. Things like trade and tax policy will have no more than a marginal effect on prosperity. What’s really important is improving productivity growth and that is a long term proposition that won’t lend itself to easy fixes.

Some things, such as the aging of baby boomers and globalization we have little control over. We can create programs to retrain older workers, who due to longer life spans can now have second or even third careers. We can also design programs to support people who’ve been put out of work by international competition and automation. But those are merely band-aids.

The truth is that if we want to win the future, we have to invest in it and that means that we have to improve our technological capacity. Unfortunately, many politicians seem hell bent on doing just the opposite, waging a war on science and cutting research budgets to post-war lows as a percentage of GDP.

And consider this. The gap in federal research investment amounts to less than 0.5% of GDP — and a mere 0.2% of GDP if you count only non-defense research. So the price for securing our future amounts to only a small fraction of pennies on the dollar. Is that really too high a price to pay?

Yet still, the issue of investment in infrastructure and research just doesn’t seem like something politicians want to talk — much less do — anything about. Never has the future depended on so little from so few. How are we coming up short?

– Greg