The US economic now seems poised for economic recovery, but questions remain about the strength and nature of that recovery. The glory days of GDP growth over five percent a year are gone. Data revisions scaled back the view of how strong growth had been in the late 1990s, and by mid-2000 a growth slowdown had started that turned into recession in 2001. Many economists, including myself, had hailed the arrival of a new economy in the late 1990s, driven by faster productivity growth and lower inflation and unemployment. But with the high-tech sector in a slump, the new economy seemed more fragile and less substantial.
This paper examines the latest evidence about the trend rate of labor productivity growth in the non-farm business sector of the US economy. This is the key economic variable that will determine the rate of potential GDP growth, how fast living standards increase, and will influence the economy’s ability to operate with low inflation and unemployment. Although recognizing the substantial uncertainty around predictions of productivity, I will argue that strong productivity growth is likely to resume with economic recovery. The productivity trend remains much faster than the sluggish growth of the 1970s and 1980s, although trend growth may not achieve quite the rate of the late 1990s. The new economy will get a second wind.
The pace of productivity growth has tremendous implications for macroeconomic policy, and the history of the last three decades is filled with misjudgments of productivity growth. The slowdown of productivity growth in the early 1970 was not recognized quickly and this error contributed to policy choices that worsened the inflation problem of that decade. In the 1980s, policymakers argued that tax cuts would induce faster productivity growth and developed overoptimistic budget predictions based on this view. In the mid-1990s, the Federal Reserve correctly perceived that trend productivity growth had increased and adopted a monetary policy that accommodated faster GDP growth. However, budget planners over this period consistently underestimated tax receipts and the improvement in the budget situation. Going forward, the fiscal outlook and the prospect of future budget deficits or surpluses depend heavily on the labor productivity trend over the next ten years.
Can Growth Accounting Track the Shifting Productivity Trends?
The precise timing of shifts in the trend rate of productivity growth is not known, but I will follow the standard productivity literature by using growth accounting to evaluate the sources of growth prior to 1973; from 1973 to 1995; and from 1995 to 2000.1 Growth accounting uses the framework of a neoclassical production function to estimate the contributions to nonfarm business output per hour coming from increases in capital per hour worked, labor quality and multifactor productivity (MFP), with the last being estimated as a residual. Table 1 gives the growth accounting estimates made by the Bureau of Labor Statistics (BLS) covering the periods 1948-73 and 1973-95. And it shows the contributions of capital services and labor quality changed little or not at all between the two time periods. The slowdown in labor productivity growth that took place after 1973 is matched by an equal decline in the unexplained residual item of multifactor productivity growth.