Productivity Cooling as US Awaits Next Big Thing

Wednesday, 08 May 2013 02:13 PM

 

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Four years into an expansion, the productivity of American workers has slowed and some economists say there are few signs it will soon rebound.

Employee output per hour grew at an average 0.7 percent annual rate over the past 12 quarters, which economists at JPMorgan Chase & Co. say is a pace so slow it’s rarely seen outside of recessions. Gains since the recovery began in June 2009 have averaged 1.5 percent, the weakest of the nine postwar expansions that lasted as long, according to IHS Global Insight.

One reason is that companies have been slow to boost spending on more sophisticated machinery and time-saving devices such as faster computers, a driver of the late 1990s boom in productivity. Without bigger gains in efficiency, it will be difficult for economic growth to gain momentum, and worker pay may suffer even as businesses are spurred to boost hiring in the short term.

“Productivity is having a very slow run,” said Michael Feroli, chief U.S. economist at JPMorgan Chase in New York. After an initial surge in 2009, “it’s been pretty disappointing since then. It means the economy’s speed limit might be lower than we thought.”

The pace at which an economy can grow without stoking inflation, which economists term its speed limit, reflects the rate of growth of the labor force plus how much each worker can produce. Smaller gains in productivity therefore mean advances in gross domestic product will also be restrained.

German Production

Signs that Germany is beginning to recover are mounting after Europe’s largest economy reported industrial production unexpectedly rose in March for a second month.

When the U.S. economy slumped during the last recession, business investment in equipment and software plunged even more, causing its share of GDP to shrink to 6.4 percent by mid-2009, almost a four-decade low. At 7.5 percent in this year’s first quarter, the share is still below both its pre-recession level and the record 9.6 percent reached in mid-2000, during the productivity boom.

“The pace of technological improvement isn’t progressing as much,” and “computing power isn’t growing as fast,” Feroli said. “We need to see stronger, sustained growth in investment spending.”

Erik Johnson, a senior U.S. economist for IHS Global in Lexington, Massachusetts, agrees. “Maybe we’re plateauing a bit in terms of the kind of gains we could get” out of digital technology advances, he said. In addition, lackluster demand and fiscal policy uncertainty mean “large capital projects that massively help supply chains and efficiency within companies have gone to the backburner.”

Next Decade

As a result, productivity is languishing, and Johnson projects it will increase 0.5 percent this year. He forecasts it will “slowly drift up” to an average 1.6 percent increase in the next 10 years.

That is still well short of recent history. From 1996 through 2004, worker output per hour rose 3.1 percent a year on average, according to figures from the Labor Department.

The plunge in prices of computing equipment during that time “gave companies the incentive to invest,” said Stephen Oliner, a resident scholar at the American Enterprise Institute in Washington and a senior adviser at the Federal Reserve Board from 1984 to 2011.

In addition, semiconductor manufacturing was in a phase of rapid innovation, and the marriage of computers and communication technology lifted efficiency, he said.

Computer Prices

Since 2004, productivity growth waned because computer prices declined at a less rapid pace and the most-productive applications of the Internet revolution were already in practice, said Oliner. More recently, funding for risky ventures that drive innovation has been scarce and companies that do have the money to spend are less willing to take chances, he said.

At the same time, Oliner says innovations in chip production are generating advances, and areas such as cloud computing may eventually reignite productivity gains.

“I don’t think it’s over,” said Oliner, who advised former Fed Chairman Alan Greenspan on productivity. “Semiconductor technology, the key driver of improvements in IT equipment, is still progressing at a rapid rate. We could have a second wave of IT-based productivity enhancement.”

Greenspan, Productivity

As productivity gains picked up between the late 1990s and early 2000s, Greenspan recognized accelerating worker efficiency would contain inflation even as the economy strengthened and unemployment stayed low. The realization allowed the Fed to keep interest rates little changed from 1996 to 1999.

In the meantime, the slowdown in efficiency need not be all bad. As companies reach the limit of how much they can wring from current employees, they’ll need to add workers as orders improve, economists including Feroli said.

“We’re at the edge,” said Richard Moody, chief economist at Regions Financial Corp. in Birmingham, Alabama. “There’s not a whole lot of latitude for firms to meet orders with their existing workers. Once we see faster demand, that’s going to spur an increase in hiring.”

The gains in employment aren’t expected immediately, nor will businesses go all out to take on more staff, Moody said. The economy has to first cope with the fiscal tightening that is projected to curb growth this quarter, and as the drag fades, demand may pick up toward the end of the year and into 2014, inducing a healthier job market.

3M Co.

3M Co., the maker of products ranging from Scotch tape to dental braces, is among companies trying to wring out more productivity by controlling expenses. The St. Paul, Minnesota-based company cut its annual earnings forecast after quarterly profit trailed estimates amid a slowing global economy.

“We’ve been managing costs quite cautiously through last year, through the first quarter,” David Meline, chief financial officer, said on an April 25 earnings call. “We’re in a position now where we’ll continue to do that until such time that we see our growth picking up more strongly, which would support incremental investments in certain areas.”

Wage gains will be harder to come by as firms restrain costs, though it also indicates inflationary pressures from labor expenses will be contained, said Guy Berger, an economist at RBS Securities Inc. in Stamford, Connecticut.

Productivity has slowed to a “crawl,” he said. “It’ll be tough to generate income gains in this environment.”

Postwar Period

In the first period of increased productivity growth since World War II, from 1947 through 1972, worker efficiency grew at a 2.8 percent annualized rate, Berger said. That meant the level of productivity could double every 20 years to 25 years, so an American worker in the early 1970s could generate twice as much output in an hour as his predecessor did in the late 1940s, he said. Those gains would be reflected in better pay and a higher standard of living.

Without a new driver of efficiency akin to the high-tech boom, the 0.7 percent rate of productivity over the past three years means it will take the U.S. about 94 years to achieve the same feat.

“Hopefully we’ll find ‘the next big thing’ before then,” Berger said.

© Copyright 2014 Bloomberg News. All rights reserved.

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