We often write about how productivity gains in manufacturing have been spectacular during the past few decades, and how unfortunately productivity has improved faster than production demand thereby creating job losses. Now we have even more evidence of the double-edged sword of productivity.
Recessions don’t usually look like this, at least when it comes to productivity. In the six U.S. recessions since 1970, worker productivity, or output per hour, grew a sluggish 0.8%, on average. But since the end of last year, even amid economic weakness, productivity is estimated to have grown an average 2.5% at an annual rate. That defies productivity’s usual behavior of going "up in good times and down in bad times," says Georgia State University forecaster Rajeev Dhawan.
Always something new to confound economists, right? This has a significant impact on policy. First the good:
That productivity is staying strong even in bad times has important implications for economic growth, inflation, employment and, ultimately, living standards. For example, strong productivity growth, by countering inflation pressures from energy and commodities, allows the U.S. Federal Reserve to keep interest rates lower than it otherwise might, helping it stoke the economy.
And the other side of the sword.
But "it’s a bit of a two-edged sword," said Chris Varvares of Macroeconomic Advisers, since efficiency gains could mean that companies can get by with fewer workers, exacerbating unemployment in the short run.
Typically laying off employees lags the reduction in demand, therefore productivity drops. However this time there is strong export growth and continuing domestic demand (note the recent number indicating actual increase in demand for big ticket items), but still overall concern which is driving layoffs, thereby actually keeping productivity bouyant.
Some economists say the current healthy growth in productivity reflects a shift in the economy from less productive domestic sectors like home building and into exporting industries, which tend to be highly efficient. That shift has been aided by the weak dollar, which has made U.S. exports more competitive.
"It’s a compositional story," said Dale Jorgenson, a productivity expert at Harvard University in Cambridge, Mass. Productivity, he explained, is "languid" in construction, so the decline of building as a share of the economy in recent quarters "is certainly going to be positive for productivity" on average.
There is also a compounding effect, driven by… you guessed it… domestic manufacturers. The ones that decided not to outsource and worked hard to become more efficient from U.S. factories.
The productivity growth in exports is well above the economy-wide average. In a paper last year, a group of economists found that manufacturing plants involved in producing exports had significantly higher labor productivity than those that weren’t. The same holds for services.
"When exports are relatively strong, that means the most productive firms in manufacturing and services are growing, and that’s going to increase aggregate productivity growth," said one of the paper’s co-authors, Andrew Bernard, who teaches at Dartmouth College in Hanover, N.H.
And, this is the first time I’ve seen this, we may need productivity improvements to compensate for a reduction in workers as baby boomers retire.
The latest period "suggests that maybe we’re still doing pretty well," with the underlying trend at 2% to 2.5% growth per year. That could help compensate for the decline most economists expect in annual labor-force growth as baby boomers retire, probably leaving the upper "speed limit" of economic growth — before touching off inflation — close to 3%.
That’s one concept to think about… and plan for.