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The New “Productivity Paradox”

In 1987, Nobel laureate Robert Solow famously observed: “You can see the computer age everywhere but in the productivity statistics.” Despite massive investment in IT infrastructure, productivity growth was nonexistent. At the time, this was known as the “Productivity Paradox.”

Since the mid-‘90s, the Productivity Paradox appeared to have been solved, as U.S. productivity growth surged. Since 1995, labor force productivity has been increasing at 2.25% per year, double the annual rate of the previous two decades. This “productivity feast,” as its been called by Fed Chairman Greenspan, is the largest increase in non-farm business output per hour in 30 years.

Therein lies the new Productivity Paradox: Productivity continues to increase year after year at 2.25%; At the same time, the labor force itself is growing at ~1% per year. Thus, Real GDP has to increase at 3.25% per year just for the economy not to hemorrhage any more jobs.

During the boom year, productivity increases got the credit for a myriad of positives: increased living standards, higher corporate profitability, boosted tax revenues, better funded pension plans. Now, we are confronting the dark side of productivity: Companies need less laborers to produce more goods and services; Less workers means less consumer spending, lowered tax receipts, weaker corporate profits.

In order to stem the tide, one of two things needs to occur: Either GDP must improve dramatically, or productivity gains must tail off, if not reverse. If neither of these events occur, the U.S. could continue to lose jobs at a disturbing rate.

Unemployment seems to have stopped getting worse, but its not yet getting better. This is what the next Fed rate cut may actually be about: Getting GDP to the point where, despite the high productivity, the economy starts creating, instead of losing, jobs. That demands a GDP over 4%.

That’s the heart of the argument favoring a ½ point rate cut on June 25. The economy probably doesn’t need more than a ¼ point cut – if even that. We could muddle along for a few Qs at a 2% growth rate, with GDP rising to 2.5-3% in ’04 . . . But that’s not what’s driving this debate. What’s on the line is not merely the economy, but Sir Alan Greenspan’s legacy as well as the President' re-election.

Any rate cut will be a near-term positive for the markets, but could lead to unintended consequences. That’s the danger when politicians start mulling over about their place in history, instead of their immediate charges.

Original reports for download:
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Thursday, June 19, 2003 | 05:44 PM | Permalink | Comments (2) | TrackBack (0)
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Comments

I think much of the "paradox" came from the way that many of the productivity increases were offset by decreases caused by the technology. As a simple example, lets say you give a bunch of people word processors instead of typewriters. Of course there should be an increase because they now can proof things online, reformat, copy, paste, spell check, etc. But initially these advantages are offset by a number of new issues that take up their time. They now have to choose a font, select a file name, decide whether to add a clipart image, etc.

Posted by: Mark | Oct 4, 2005 11:17:58 PM