THE COMING TEST FOR PRODUCTIVITY GAINS
Productivity growth for the U.S. economy in the third quarter rose by 3%. That's a strong showing, especially so late in a business cycle that will enter its 94th month of expansion in January (beating the previous record peacetime expansion, in the 1980s). In fact, productivity growth for the past three years has averaged about 2%, nearly twice the 1% rate of the '70s and '80s. This is an important achievement. It suggests that productivity growth may be returning to its historic trend of 2%, permitting sustained high economic growth, low unemployment, and low inflation well into the next century.
But the numbers are not conclusive. Over the past 30 years, there have been four three-year periods where productivity growth averaged 2% before falling back below that level. Is the 1996-98 period a temporary bump, or the beginning of a sustained era of high productivity growth? We just don't know.
Then there is the problem of measurement. Recent revisions by the Bureau of Labor Statistics changed the way the inflation rate is calculated to better reflect price fluctuations. This lowered the official inflation rate and automatically raised growth estimates for both gross domestic product and productivity. Are the revisions giving a false picture of U.S. productivity growth? We don't know.
On the other hand, productivity gains in banking and finance, huge sectors of the economy, don't show up in official stats, either (page 76). Thanks to computers, globalization, and math wonks who dream up new algorithms, capital markets are much more efficient than before. In the mortgage market, for example, gains in efficiency are leading to reduced costs and lower interest rates. This is allowing people to refinance their mortgages multiple times with relative ease. Yet productivity gains in the mortgage markets are not counted. They show up only as hikes in consumer spending, as people take their refi money and buy gifts for the holidays. So is productivity even higher than the numbers show? We don't know.
The real test is ahead. If high tech and globalization have combined to lift productivity back to a 2% or higher annual growth rate, then the next year or two should prove the case. Productivity has done well in the past three years in part because the economy has been so strong. But it must also perform well in an economic slowdown before a definitive answer can be made. That slowdown is approaching. Our best guess is that the growth in productivity is no three-year wonder. But we await the test results to be sure.