FT Alphaville " Productivity post-paradox We noted in an earlier post that an optimistic near-term scenario for US employment would likely mean productivity growth remaining at its depressed rate for a little while. The alternative - productivity growth returning back up to pre-crisis trend - would have to coincide with sluggish employment growth unless economic growth were to pick up significantly. But of course, productivity is just a mathematical relationship. For short-term trends you need to make adjustments for changes in what economists call "factor utilisation" - a technical way of describing how much employers get out of their workers (when the "factor" is labour) or out of existing technologies. Payrolls, for instance, stayed depressed even as output and company revenues increased (measured productivity growth went up) followed by a period throughout roughly the past year in which employers began hiring more rapidly to compensate for their excess caution earlier. Measured productivity growth went down, actually turning negative in the first quarter of 2012. So without these adjustments, and others for short-term influences such as measurement error and labour force changes, measured productivity doesn't tell you very much. But a sharp-eyed economist reader just sent us to a preliminary and incomplete paper from John Fernald of the San Fran Fed, which includes some of these adjustments and arrives at a few other interesting findings. We aggregate some of them below... 1) The productivity growth trends in the aftermath of the last recession are actually quite similar to previous recessions: Informal commentary instead often suggests that productivity performance was unusually strong inthe recession and early recovery. Consistent with my results, and in contrast to the informal commentary, Gali, Smets, and Wouters (2012) also point out that productivity performance following the 2007-9 recession has been fairly typical. As a result, they argue that the recoveries should be described as "slow" rather than"jobless." In the results here, a rebound in factor utilization explains much of the early-recovery surge in labor and total factor productivity. 2) Labour productivity growth had already fallen off its temporarily higher pace of the mid-90s through 2003 by the time the recession began: If you want precise numbers, business sector labour productivity grew an average of 3.7 per cent annually from the first quarter of 1997 through the third quarter of 2003. Since then, it has averaged 1.6 per cent a year. 3) The productivity growth slowdown in the mid-2000s resulted from a "waning of the exceptional growth effects of information technology as a general purpose technology (GPT) ." The relevant excerpt from the paper is on pages 7-9 and the ideas will be well-known to many economists, but it's very technically written and here we'll try to explain it in plain (er) English. Everybody knows that in the mid-90s there were big improvements in information and communications technology, with significantly higher labour productivity growth in the sectors that produce these technologies. And there was also an indirect influence, as naturally companies in other sectors invested in and used these technologies to also increase productivity. This is what "general purpose technology" means - something new that has an impact throughout the broader economy and upends how things are done everywhere, not just in select industries. So far, so obvious. Only there was a lag before a business in the second category - IT users rather than IT producers - could reap the productivity gains. It first had to make what economists call "intangible investments" to complement the use of these new technologies, and it had to restructure itself to accommodate them. This could mean changing a company's physical infastructure to accomodate new machines, hiring technicians to handle them, investing in the right software, shutting down newly obsolete business lines or letting go of workers whose jobs have been automated, retraining existing employees, etc... But such a reorientation will slow productivity growth before raising it. This is sometimes called the productivity paradox. So here is what Fernald is getting at. Starting in the 1990s, we didn't just get the big productivity gains in the IT-producing sectors, we also had other sectors making these investments throughout the period. Some businesses started earlier than others, but the point is that these business reorganisations continued until peaking in the year 2000, meaning that productivity growth during that time was slightly lower than it otherwise would have been if there were no reorganisation taking place. And after it peaked in 2000, when the internet stock bubble also started deflating, productivity growth remained strong for three more years. In addition to the familiar factor utilisation changes following the 2001 recession, there were two reasons for this: one is that companies were still reaping the benefits of their earlier intangible investments, and another is that measured economic output was closer to its "true" amount now that companies were making fewer such investments. Unfortunately, here is what happened next: Fundamentally, the General Purpose Technology benefits of Information and Communications Technology on growth had to end. It was just hard to know when that would happen. With a lag, productivity growth in this story would end. As Oliner, Sichel, and Stiroh (2007) note: ...intangible investment has been quite sluggish since 2000, coinciding with the soft path for IT capital spending. All else equal, this pattern could be a negative for labor productivity growth in the future to the extent that these investments are seed corn for future productivity gains. 4) The last recession has had no discernible lasting influence on Total Factor Productivity growth: Indeed, growth is nearly identical in the four years before 2007:4 (1.61 percent) and the four years after (1.65 percent). So there is little evidence here that there was a further influence of the Great Recession on TFP growth. We'd note again that total factor productivity can be difficult to measure, an amorphous concept. It's a residual, or what's left after taking into account the impact of improvements in labour quality and capital deepening. Since you could argue that productivity itself is a residual, that would make TFP a residual of a residual. And although TFP growth is often considered to represent the fundamental pace of technological innovation, it can also include measurement errors and other temporary factors, at least in the short term. Fernalt then uses a number of assumptions to estimate potential GDP growth under different scenarios for future productivity growth, though he kind of lost us on this part. He estimates that potential GDP growth is now around 2.2 per cent, but seems to assume that growth in the years between 2003 and 2007 was somewhat above potential, and the shortfall since (relative to the trend in those years) is half "a revision to potential, and half is an output gap." We have no idea about that, and would note that estimating output gaps is a notoriously fraught exercise. But the questions of whether the recession had any kind of meaningful impact on innovation, and what happens next, and how it influences employment in particular, will likely be with us for some time. It's why Race Against the Machine - one of whose authors, Erik Brynjolfsson, is cited repeatedly in Fernald's paper - made such a splash when it was released. Expect many more papers like Fernald's as economists continue to scrutinise these issues. Related link: When productivity normalises - FT Alphaville This entry was posted by Cardiff Garcia on Thursday, June 28th, 2012 at 23:20 and is filed under Capital markets. Tagged with productivity, productivity paradox.