We have grown accustomed, in the past couple of years, to monthly jobs reports from the U.S. Bureau of Labor Statistics that announce good news. The unemployment rate has fallen from 10.0% in 2010 to 4.9% in August 2016, and new job growth has been, for the most part, strong. But the BLS releases another gauge of the U.S. economy each month that is less reported but, arguably, just as important: labor productivity. And the recent news regarding productivity is not so good.
Productivity simply means the average output per hour of each U.S. worker. Why should we care about that? Because, over the long term, real economic growth depends on only two components: labor force growth and productivity growth. There’s some logic to that: the American economy can grow only if there are more workers or if the productivity of each worker increases. We know that our population is aging. The Baby Boom generation started turning 65 in 2011. With big constraints on labor force growth, the pressure on American workers to become more productive is becoming more acute.
Here’s the concerning news: With a fall of 0.5% in the seasonally adjusted rate for the second quarter, productivity has now fallen for three consecutive quarters. That is the longest streak of falling productivity since 1979. Those of us that remember the hopeless feeling brought about by Stagflation—the combination of roaring inflation and very slow growth—in the 1970s are not anxious for a repeat.
Why is the decline in productivity happening? There are at least three reasons. First, productivity has historically been cyclical. Productivity growth averaged 2.8% annually from 1947 to 1973, then fell below 2% annually from 1973 to 1990, then grew robustly in the 1990s and early 2000s. So, a turnaround on productivity could happen naturally as part of longer term economic cycles.
Second, the American economy is now overwhelmingly a service-based economy. Seventy-eight percent of GDP in 2015 was produced by services. Making a service worker, like a waiter or insurance agent, more productive is trickier than doing the same for an industrial worker. Americans have been wonderful at innovating machines to make industrial workers more efficient at their jobs, but there’s a limit to how many plates a waiter can carry in an hour.
The third reason for declining productivity is the reluctance of businesses to spend more on investments that might make workers more productive. Fixed nonresidential investment and new orders for nondefense capital goods have also fallen in recent quarters. Economists have different ideas about why this is so. The slow growth hangover from the Great Recession may still be making business leaders reluctant to invest more in their companies. And, until very recently, slow wage growth made it more rational to hire new workers at lower wages than to spend on investments that might make current workers more productive.
How might we jump start productivity? A significant federal investment in infrastructure might help. Creation of the federal interstate highway system in the 1950s increased productivity significantly, as business were able to produce and transport goods more cheaply. Remarkably, this is the rare point on which our major party candidates for President agree. Secretary Clinton has called for $275 billion to be spent over the next five years on infrastructure improvements. Mr. Trump wants to double that amount.