U.S. Productivity Growth: Down, Up

Over time, America’s standard of living has been driven by productivity growth. Michael Peters succinctly explains this in “America Must Rediscover Dynamism.”Finance and Development(September 2024). He wrote:

The U.S. economy has a multi-trillion-dollar problem. Productivity growth has slowed dramatically over the past few decades. Between 1947 and 2005, U.S. labor productivity grew at an average annual rate of 2.3 percent. Since 2005, it has fallen to 1.3 percent. This seemingly small difference has surprisingly big consequences. According to the Bureau of Labor Statistics, if economic output per hour worked had continued to grow at that 2.3 percent rate between 2005 and 2018, the U.S. economy would have produced $11 trillion more in goods and services. This is part of a broader trend across advanced economies. Productivity growth in Europe has been slower than in the U.S. As a result, Europe has fallen far behind the U.S. in GDP per capita. Productivity is a key driver of economic expansion.

What is the main cause of this problem? Peters argues that the development of information technology is related to economies of scale. That is, large companies are best positioned to exploit new information technologies, which makes it difficult for small and medium-sized companies to enter the market dynamically. As a result, the major productivity gains from information technology are mainly in large companies rather than being spread throughout the economy. Peters writes:

When discussing productivity dynamics in the 1980s and 1990s, the emergence of IT is the elephant in the room. Could the availability of such technologies have led to a decline in the dynamics of productivity growth and a distinctive boom-bust pattern? Two recent papers argue that the answer is yes, and that economies of scale play a role. French economist Philip Aghion and his research collaborators (2023) Advanced IT has made it easier for companies to expand their operations across multiple product markets, according to the London School of Economics. Marten de Rieder (2024) IT, they argue, allows firms to reduce marginal costs of production rather than increasing fixed costs.

What these explanations have in common is that the introduction of these technologies is particularly valuable to productive firms, which means that these firms took advantage of IT developments in the late 1980s and early 1990s, and the economy experienced an early productivity boom. Even more strikingly, the researchers argue that the presence of these giants can have long-term dynamic costs. If new firms (e.g., new IT startups) expect to have difficulty competing with incumbents who produce at scale (e.g., Amazon, Microsoft, or Google), they have less incentive to enter the market. As a result, overall growth and creative destruction can be reduced, and incumbents profit by charging higher markups. …

Separate research suggests that the process of knowledge diffusion between firms has fundamentally changed. In particular, in recent decades, technologically backward firms have had difficulty adopting technologies from competitors at the forefront of productivity. This change may be technological in nature: firms like Google or Apple may be so technologically advanced that it is impossible for smaller competitors to adopt their technologies. At the same time, it may have legal origins, as large firms increasingly engage in defensive patenting, creating dense, overlapping patent thickets to protect their technological advantage. Consistent with this hypothesis, Ufuk Akjit and Sina Eyats (2023) We document that patent concentration has increased significantly among large firms, and speculate that this may explain why changes in technology adoption have become less dynamic, why incumbents enjoy uncompetitive rents, and why productivity growth has slowed.

The dynamic of productivity gains being captured by industry leaders rather than spread across the economy has been mentioned several times in the past on this blog (e.g. here and here ). Technology diffusion is difficult (for a historical example, here is a previous post on the diffusion of forks into cutlery). A report just released by the European Commission said: Mario Draghi on “The Future of European Competitiveness” It highlights how far Europe’s small and medium-sized enterprises are lagging in productivity growth.

There are other potential causes for the productivity slowdown. A related idea is that the economy may have slowed down the rate at which it reallocates resources from less productive firms and sectors to more productive ones (see here and here) As Peters points out, various growth models suggest that lower population growth can also lead to lower economic dynamism and lower productivity growth. A recent study by the McKinsey Global Institute suggests that lower productivity levels are largely due to lower levels of investment in tangible capital.

Any encouraging signs? In the same September 2024 issue of F&D, Nicholas Bloom argues that “working from home helps increase productivity.” He listed a number of reasons why people who work from home at least a few days a week may be more productive: 1) Avoiding a commute means you can get your work done in less time; 2) Employment of people with disabilities has increased dramatically since the pandemic.Especially in telework occupations; 3) employment of prime-age women has also increased since the pandemic, perhaps in part because they sometimes work from home, making it easier for families to juggle childcare responsibilities; 4) telework involves more intensive use of residential space. Commercial office space, now partly used as workspace, is used less intensively and can be reallocated to other uses; 5) tWith more people working from home, raffic is moving a little faster.And even if it were just a few minutes faster on average, it would add up to a significant time savings for all commuters, and it would also reduce pollution. 6) A positive feedback loop would form as more people work from home, and as software tools and business practices that reduce costs and increase the benefits of working from home emerge.

I don’t expect telecommuting to solve the productivity problems in the US and Europe. In fact, many of the benefits Bloom mentions, such as reduced commuting, are very real and are not well captured in economic statistics on output and hours worked. But at least some preliminary evidence suggests that the economic disruption of the pandemic has led to a surge in new US businesses, at least some of which are clearly taking advantage of telecommuting and information technology.