One of the major mysteries facing economists today is the slowdown in labor productivity in the U.S. and most of the other major industrial countries. Concern over this situation has reached such proportions that the topic got the lead editorial position in the Financial Times on Monday.
The basic issue is this: The current economic recovery, which will reach seven years at the end of this quarter, has been anemic at best. The compound annual rate of growth in the U.S. economy during this period has been a tepid 2.1%. More and more, it appears as if this modest recovery has been the result of a slowdown in the growth of labor productivity.
The Conference Board has released a report that indicates that labor productivity, measured as economic output per hour, is expected to decline this year in the U.S. Although the growth in labor productivity has been falling in recent years, this would be the first time in more than three decades that such a decline has taken place. As labor productivity slows, economic growth slows, regardless of the short-term monetary or fiscal stimulus that is applied to the economy.
Here's a hypothesis of why this has happened. The credit inflation of the past 60 years or so has changed the nature of the economy, which has resulted in the slower growth of labor productivity and the slower general economic growth.
First, the credit inflation created by the government's fiscal and monetary stimulus has resulted in relatively more and more credit creation going into financial services, financial speculation and financial innovation as sophisticated investors came to expect the actions of the government.
This all began in the late 1960s and early 1970s as the wealthy moved into gold, homes and art, among other things. One can see the consequences of such speculation in art treasures in the recent article in the The New York Times' article "Masterpieces Tucked Away to Appreciate, Not to Be Appreciated."
Furthermore, labor productivity does not rise as rapidly in the financial services area as it does in industrial production.
Second, the short-term, cyclical efforts of the government to stimulate the economy through monetary and fiscal policies are aimed at getting existing industries back up to full capacity and by reducing unemployment to where workers are fully employed. That is, these government efforts are an attempt to keep businesses and workers doing what they did before the economy went into a recession.
These efforts did not seem to work over the longer run, however. For example, the capacity utilization of manufacturing in the U.S. has trended downward since the late 1960s, from just under 90% of capacity to around 75% percent in April 2016. In addition, the labor force participation rate has fallen to less than 63%, a level not seen since late 1977. Something is wrong when resources are not being fully used. Obviously, there seems to be a mismatch between what business and industry needs and how resources are being allocated.
One factor affecting this mismatch seems to be that uncertainty is pervasive in both industry and labor. Businesses are not investing as they once did and workers don't seem to be as willing to move as they once were.
The consequence of all of this is that U.S. economy is just not as responsive to monetary and fiscal stimulus as it once was. Just "goosing up" the economy is not as effective as it once seemed. And, in fact, artificially stimulating the economy might even be counterproductive in the longer run.
This means that other efforts are needed in order to produce increasing labor productivity. Unfortunately, most of these efforts have a longer-term horizon than does the short-term stimulus programs of the government, and this makes these other efforts less desirable to politicians.
In addition, the reforms in the economy that are necessary to help produce greater labor productivity are often strongly resisted because they change the way people have to do things. Politicians, also, do not like to be seen as a cause of this kind of disruption.
I will be writing more about this predicament in the near future, because problems related to slow economic growth are more connected to the weak growth in labor productivity than to the secular stagnation that some economists, such as former Treasury Secretary Larry Summers, have cited.
The issue of slow productivity growth is, I believe, one of the most important issues in the U.S. that must be addressed in the near term.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.