Four times a year, America gets an economic report card, gross
domestic product or GDP for short. GDP is like a grade on
the health of the US economy. But what if I told you a similar
report card also comes out every quarter for the average American
worker, a grade on how efficient we are at well, working? Enter
the productivity metric. Labor productivity is the amount of
output that's produced per hour of work. It sounds like a very
sort of technical or even pedestrian kind of thing. But
it's actually the key to how well we live. But U.S.
productivity has been declining, and the reasons behind the
decline, from the pandemic, shifting workplace trends, to
even rising temperatures, are up for debate. As we've seen in the
recent reports, businesses are actually reporting a downturn in
productivity as a result of the work from home environment. The
jury's still out as to whether or not work from home
constitutes a productivity enhancement, or a productivity
decline. We hear a lot about burnout, we hear a lot about
employee engagement, we hear a lot about kind of the things
that are standing in the way of productivity. Much of the
country continues to battle excessive heat record
temperatures nationwide, it's also having a major effect on
workplace productivity. I think the probably the biggest reason
for the decline of productivity is bringing back on board lower
productivity workers. So just how is productivity measured?
How effective of a metric is it for economists? What's behind
the slowdown in productivity? And what impact does it have on
the overall U.S. economy?
Labor productivity is output per hour. And it's how many widgets
you make in an hour, if you can make more widgets in the same
amount of time. And you can do that broadly across an economy,
it means you're going to live better. The calculation is
essentially looking at output growth for the overall economy,
generally, the nonfarm business sector and comparing that with
the hours worked in the same sector. So it's an attempt to
figure out how efficient workers are, if you can produce a lot of
output with an hour of work, you're very productive. If you
can't produce very much, it's quite low. The two sources of
growth we have are can you work more hours? And can you be more
productive in the hours that you work? And what does the metric
say about our economy? Productivity sometimes is
telling you how efficient you are, you know, the United States
has higher productivity than India, because workers produce
more per hour in the United States than they do in India.
Sometimes it tells you cyclical things. So for example, if
people, you know, get nervous and stopped going to
restaurants, it might look like productivity went down, because
output per hour went down. It isn't that you're any less
efficient than you were before. It's just that, you know,
something bad happened to your economy. Economists agree there
are flaws in the metric itself. Particularly when it comes to
the volatility and readings. On a quarterly basis, it's very
volatile. Because if you make a mistake in measuring GDP, or you
make a mistake in measuring employment, or you make a
mistake in measuring average hours, any one of those will
translate into a mistake in productivity. Productivity
measurement is full of lots of flaws and problems. The quarter
to quarter, year to year productivity numbers are really
flawed, they come back and they adjust them. They restate them.
So there's a lot of things that can go wrong, so every quarter
it bounces around a lot. That's why economists tend to like to
look at it over maybe at least a two three year period to try to
judge what's going on. Economists also say the metric
doesn't fully capture productivity in the workplace,
from difficulty in calculating work hours, to accurately
measuring productivity in today's service economy. Our
government is so far behind in measurement issues, that I
personally don't pay too much attention to the official data
on productivity. The one thing that makes me worried is that
it's hard to define work hours. You might shop online during the
day while you're at your office, and you might log onto your
computer to finish a memo at night. You know which of those
was recorded as work which of those was recorded not as work?
But in an environment where output is rapidly fluctuating,
where hours worked are also rapidly fluctuating, it's even
more difficult to get a precise read on productivity growth. So
I don't think we really know anymore what productivity is
accurately because we're a service economy, but we don't
really measure the flow of services. Back when we were an
industrialized, even agricultural country, it was
easy to measure widgets, so to speak. You could do that and
bushels of wheat, you could do it in output of cars or output
of nuts and bolts. But now the US economy is primarily a
service economy. So measuring widgets and measuring the
productivity of widgets is very difficult. What happens, how
productive is a bank teller? What happens to bank teller
productivity when you bring an ATM on board? How productive is
an accountant? How much different is that productivity
when they have things like accounting software that does a
lot of the job for you?
So we're currently in an environment where we've seen a
significant drop in productivity growth. Over the past five
quarters, we've had consecutive quarters of contraction in
productivity. And never in the past 60 plus years, the data
starts in 1948, have we seen this type of slump in
productivity. In the most recent round of data, the Labor
Department reported a 3.7 percentage increase in the
nonfarm productivity in the second quarter of 2023, equal to
a 1.3 percentage increase year over year, reflecting a rebound
in worker productivity. Now, we have seen somewhat of an uptick
in productivity from record low levels, the U.S. economy was
seeing a less than half a percentage point of productivity
for a prolonged period of time, slowing labor productivity is
not a new issue to the US and is an issue that's been raised in
the past, as seen from these reports from the Congressional
Budget Office and the Boston Federal Reserve Bank in the
1980s and 90s. But economists say the downtrend this time is
different. The productivity we've experienced, if you
measure it from the end of 2019 to the present, so looking
through the pandemic period, has been about a 0.8% annual rate.
Even the slowdowns that people like CBO were concerned about in
the past, were productivity more like 1.5 to 2%. So we're quite
slow, even compared to the past periods where people angst about
the slowdown. That is highly unusual, and is reflective of an
environment where output growth has slowed, but where the hours
worked, the amount of labor that is put into the economy, has not
slowed nearly as much. So productivity has slumped as a
result of that mismatch. Now, one of the first reasons that
come to mind for many to explain the decline is the Covid 19
pandemic. Yet some of the workplace changes at the early
onset of the pandemic, from mass layoffs to the shift to remote
work, may have actually had the opposite effect on productivity.
So productivity growth surged after the pandemic hit. And the
reason that surge was because we got rid of or fired or otherwise
laid off or sequestered, more low productivity workers in the
economy. So what was left were the more productive workers.
During the initial phase of Covid, there was this
perspective that people were being much more productive, and
that productivity growth had actually accelerated during the
initial phase of Covid, because people were not commuting
anymore. A more plausible explanation then could be some
of the workplace shifts that happened later on, starting with
'The Great Resignation', to the rehiring of workers as a
pandemic subsided, and companies now holding on to their
employees amid economic uncertainties. If you look at
the employment data, we brought on an awful lot of people back
to work and added a whole lot more jobs. You know, more than 2
million jobs so far this year. And with the churn that was very
rapid over the 2020 2021, and even 2022 period, we had a lot
of new individuals on the job. And that amount of training, in
my opinion, was a constraint on productivity growth, because it
meant that you had to train the new talent to be as productive
as the old talent. It's hard when people a) first start their
job, and b) when managers have a lot of new workers out there to
be as productive as you can. You know, a waiter doesn't know
where the water is or where the menus are, and then they learn
and then they're really efficient the job, they can wait
more tables. But, you know, day one or week one, they're not
waiting a whole lot of tables. So that's the optimistic version
of the slowdown, is that lots of workers have switched their jobs
in the last couple of years. Conversely, you know, one thing
that may have been happening in especially 2022, is businesses
were holding on to their workers. This idea of labor
fording is that over the past 18 months, a lot of business
executives have really struggled to hire, train,
and retain their workforce. And in that environment they're
reticenct to let go of that price pool of talent, even if
final demand is weakening. Even as sales in some businesses
slipped, they were nervous: 'Will I ever get a worker
again?' I'm going to hold on to my workers. So sales were
slipping, you hold on to your workers, and productivity goes
down. The unsettled economic environment may also be having
an adverse impact for worker productivity on an individual
level. Right now, we've been navigating an economic
recession, the potential of an economic recession, that is
distracting for people. People's stress and anxiety levels are
higher, and therefore their energy is going towards that
stress and anxiety. They're going to be looking for other
jobs, be nervous, and therefore they're not in their most
creative mode. They're not in their most productive mode,
they're distracted, and they're stressed. Another explanation,
and perhaps the most optimistic reason is that the productivity
boosting tools and technologies simply have not shown up in the
data yet. Now there's one big wildcard in that, which is the
productivity data is probably not showing anything about the
recent advances in artificial intelligence. This have not been
widely deployed enough throughout the economy to affect
the data. That is some real upside potential. It's been said
for 30 years that we know that computers are more productive.
But where does that show up in the economy? This was a puzzle
that one of the great economists of our age, Robert Solow, the
Nobel laureate, put already in the 1980s. The so-called Bob
Solow paradox, in which Bob Solow said famously that the
computer age in the 1990s was visible everywhere except in the
statistics. And we had to wait until the early 2000s to see a
very strong acceleration in productivity growth in the
actual economic data.
You do not want to be, for a prolonged period of time, in an
environment where productivity remains quite weak, because we
productivity tends to lead to weaker living standards. And
that is exactly the opposite that anyone wants to wish upon
any economy. Sluggish productivity means sluggish
growth. It means sluggish wage growth and increase in living
standards. It means a much more bigger challenge in managing our
public debt and our deficits. It matters for just about
everything in the economy. On the flip side, strong labor
productivity can present a major growth opportunity for the U.S.
economy. Economists at McKinsey and Company say boosting U.S.
productivity and regaining historical rates of productivity
growth could add as much as $10 trillion to U.S. GDP between now
and 2030. Strong productivity gives you faster economic
growth, it gives you a faster increase in living standards, it
makes your debt more manageable. It's just about the most
important thing in an economy. The stronger your potential
growth is, the stronger your potential income growth is also
going to be. And so if you're producing twice as much per hour
as you were before, you're probably going to be paid about
twice as much per hour as you were before. And that means that
households across the country will typically benefit from an
environment where they have stronger income growth, and
where they have also reduced inflationary pressures. So the
best of both worlds in terms of higher nominal income and
reduced inflationary pressures, which boosts inflation adjusted
income and supports higher living standards.
In general, our economy is so transformed in what it does, how
we live, how we work, how we shop, that we really are not
comparing accurately year-to-year in meaningful ways
right now. We need an overhaul of the basic national accounts.
And one of the difficulties with productivity is there's not
really a dial that policymakers have. You know, if the inflation
rate is too high, the Fed raises interest rates. If the
unemployment rate is too high, the Fed cuts interest rates.
There's no dial like that for productivity growth. When we're
asking what's really happening to how we produce and what the
what the changes in goods and services are, we were not
measuring these things very accurately anymore. And I think
that is certainly one of the areas where there could be
further improvements, measuring the intangible part of the
economy, things that pertain to the digitalization of the
economy. So to my mind, we should be improving what we're
measuring, and then we could decide what the real puzzles are
after we get the measurements a little bit better. So while
completely overhauling the productivity metric may not seem
imminent, there are practical ways to improve productivity
that could set companies and the U.S. economy up for long-term
success. I think we do have a new generation of folks coming
into the workforce who don't want to work the way that we've
worked. And I think that's okay, in the sense that, I think we
might need to disrupt the way that we're working in in ways
that are important. So companies have to figure out how to best
manage things like remote work. And on a public policy level,
you know, there's no one lever, but more investments in research
and development, more investments in infrastructure.
And ultimately, education is just a huge, huge factor in
this, but that takes a while for it to change and make its way
through the economy. If we really took a step back and
challenged the way we worked, and the way that we think of
value creation, we could create a lot more value in in ways that
actually are more humane, frankly. Humans are energetic
beings. They have a certain amount of energy, and that
energy can be applied to a myriad of things. And if we're
burning down on energy constantly, we're in an energy
crisis. And I think we are. And I think we need to reset on how
we use energy and how we leverage it in order to actually
create a better paradigm. For now, as companies look for ways
to boost productivity growth. economists agree the outlook is
a positive one. My guess is we're going to be in a period of
sustained, better productivity growth because I think we have
to. I'm actually quite encouraged by the prospects for
productivity growth. And it might sound a bit of a paradox
amidst today's slump in productivity growth to be
optimistic about the outlook. Yes, we have higher rates from
the Fed. Yes, we have a slowing economy. But meanwhile, we have
this offset from better functioning. The economy's
functioning better, less supply chain frictions, much lower
labor turnover. All of that spells a productivity dividend
for companies. And that's the secret sauce of non-inflationary
growth. We are in an environment where cost constraints are still
very much present for businesses and business leaders. That will
put a lot of the focus, a lot of the emphasis on improving
workflows and ensuring that the existing workforce is as
efficient as possible. So at least for the near-term, I think
we're set for a pretty positive performance in the U.S. economy
as as we just operate better and more efficiently. The worker
shortage that's out there, and the need for workers to become
more productive, I think companies will respond and
workers will respond to become more productive because they
have to.