The Truth About Labor Market Productivity
Rick Rieder explains why slowing productivity is a statistical mirage.
One of the greatest economic mysteries out there, according to many market watchers: Why labor market productivity has slowed sharply around the world in recent years.
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As my co-authors and I write in a new BlackRock Investment Institute paper, “Productivity Slowdown Puzzle: Structural, Cyclical or Erroneous,” the slowdown in productivity matters. In a world where developed market workforces are shrinking thanks to aging populations, productivity will be the key driver of potential economic growth rates in the long term.
But in my opinion, the labor market productivity slowdown mystery, puzzle or whatever you want to call it has a simple solution: It’s a statistical mirage. As Nobel Prize-winning economist Robert Solow famously put it back in 1987, “You can see the computer age everywhere but in the productivity statistics.”
I’m of the camp that traditional economic metrics simply haven’t kept pace with fast-changing technologies geared toward greater efficiency at lower cost. In other words, official numbers don’t capture the productivity gains coming out of new, often free technologies. The calculations behind the data understate the benefits of innovation — and as a result, underestimate productivity.
Technology is changing the world in ways never before witnessed. U.S. consumers are adopting new technologies such as smart phones at the fastest rate since the advent of the television, and this is resulting in the widespread use of app-based innovations that arguably enhance productivity, but are unaccounted for in official data. Just one example: free apps that allow us to learn a language or check road conditions.
At the same time, new technologies are also bringing greater efficiencies to businesses at lower cost. Think cloud-based computing, energy-sector fracking, the sharing economy, improved data storage, enhanced computing power, developments in robotics and inventory management systems, which enable asset-light business models and drive down the cost of corporate investment. An area where this greater efficiency is showing up: lower inventory levels. Approximately one-fifth of the largest 1,500 U.S. companies by market value now have zero inventories, up from 5 percent in 1980, according to Morgan Stanley data.
Statisticians try to factor in such improvements by tweaking price deflators. Yet I believe such deflators still understate quality improvements — and, therefore, true productivity. In short, they don’t fully account for technology’s downward influence on price.
Consider technologies’ quality improvements and downward influence on prices, and productivity growth starts to look much better than it first appears. In fact, understated productivity means real annual U.S. gross domestic product (GDP) growth may have been 0.7 percent higher than reported over the past five years, Goldman Sachs estimated in a July 2015 report.
Looking forward, if the productivity slowdown is simply a mirage, then both actual and potential economic growth are understated, and we could see a gradual lifting of productivity estimates over time as measurement errors are corrected.
That said, given that the understated growth of the past few years was still quite solid and the labor market probably experienced its cyclical peak at the end of 2015, there are signs that the U.S. economy is actually decelerating now, and higher productivity estimates are unlikely to reverse this trend. As I’ve long argued, this means the Federal Reserve likely began normalizing rates too late, and it may now have to initiate more quantitative easing over the next year or so.
However, in the very near term, monetary policy will likely remain the same, and I’m not holding my breath that statisticians will suddenly see the error of their ways on the labor market productivity front. In the meantime, the low productivity myth shouldn’t be so readily accepted.