[An updated version of this article can be found at Productivity in the 2nd edition.]
Productivity—the amount of output per unit of input—is a basic yardstick of an economy's health. When productivity is growing, living standards tend to rise. When productivity is stagnating, so, generally, is well-being. "It can be said without exaggeration that in the long run probably nothing is as important for economic welfare as the rate of productivity growth," wrote Princeton economists William J. Baumol and Sue Anne Blackman, with New York University economist Edward N. Wolff, in Productivity and American Leadership.
Productivity can be defined in two basic ways. The most familiar, labor productivity, is simply output divided by the number of workers or, more often, by the number of hours worked. Output can be anything from tons of steel to airline miles flown, but more generally it is some very broad aggregate like gross domestic product. Measures of labor productivity, however, actually capture the contribution to output of other inputs than hours worked.
Total factor productivity, by contrast, captures the contribution to output of everything except labor and capital: innovation, managerial skill, organization, even luck.
The two productivity concepts are related. Increases in labor productivity can reflect the fact that each worker is better equipped with capital—a supermarket clerk who has an automatic scanner instead of an old-fashioned cash register—or, alternatively, gains in total factor productivity. Thanks to specialization, for example, Adam Smith's pin factory turned out more pins with the same number of craftsmen and identical tools. And General Motors' Fremont, California, plant—once one of the worst in the company—had a productivity turnaround when it required its workers to use Japanese manufacturing methods.
While factors of production like land will always be scarce, the potential for increasing total factor productivity is limitless. At least half, if not more, of the growth in labor productivity in the post-World War II period has been due not to the use of added capital, but to making better use of these inputs. The United States produced 65 percent more in 1981 than in 1948 from the same quantity of labor and capital resources.
Gains in living standards are tied to productivity gains. There are only three ways that a nation can enjoy a rising level of per capita consumption. First, a bigger proportion of the population can go to work. Second, a country can borrow from abroad or sell assets to foreigners to pay for extra imports. Third, the nation can boost productivity—either by investing a bigger share of national income in plant and equipment or by finding new ways to increase efficiency.
In fact, the United States has done all three at different times. But there are limits on how many Americans can join the labor force and on how much foreigners will lend. For most countries most of the time, the "lever of riches," to use a term coined by economist Joel Mokyr, is rising output per hour of work.
In the United States, labor productivity growth has averaged about 2 percent a year for the past century. That means living standards have doubled, on average, every thirty-five years. America's place in the sun reflects its productivity. The number one country in the world at any given time has always been the productivity leader. It was northern Italy from the thirteenth to the sixteenth centuries, the Dutch republic in the seventeenth and early eighteenth, Britain in the late eighteenth and most of the nineteenth, and the United States for the entire twentieth century.
Now the United States faces two productivity problems. First, its productivity growth has slowed sharply since 1973, part of a puzzling worldwide productivity slow-down. Second, although U.S. productivity is still the highest in the world by a wide margin—$45,918 of GNP per worker in 1990, 25 percent ahead of Japan and 35 percent ahead of Germany—its productivity growth trailed that of other nations in most years since World War II. That has stoked fears that the United States will eventually fall behind. After all, British productivity from 1880 to 1990 grew just 1 percentage point more slowly than that of its trading partners—hardly a huge shortfall, but enough to transform the once proud empire into a second-rate economy in little more than a lifetime.
"Compared with the problem of slow productivity growth," wrote Paul R. Krugman in The Age of Diminished Expectations, "all our other long-term economic concerns—foreign competition, the industrial base, lagging technology, deteriorating infrastructure and so on—are minor issues."
Economists caution that lagging productivity growth is, by its nature, a long-run problem. "The tyranny of compounding manifests its full powers only in longer periods," write Baumol, Blackman, and Wolff, who maintain that it is not yet clear whether the productivity slowdown in the United States and elsewhere since the early seventies represents a long-term shift to a lower growth path or a temporary aberration.
According to the Economic Report of the President , U.S. productivity growth can be divided into three distinct phases. After averaging 1.9 percent a year from 1889 to 1937 and an even stronger 3 percent during the twenty-five-year boom that followed World War II, productivity growth has averaged a mere 1 percent since 1973. In spite of the supply-side revolution of the early eighties (which brought, among other things, lower inflation and lower marginal tax rates), productivity growth failed to revive in the past decade.
As a consequence of slower productivity growth in the past two decades, average compensation has edged up only slightly faster than the price level. Living standards have increased largely because more Americans, especially mothers, have been working, and because the United States has been able to attract capital from abroad to offset a persistent trade deficit. "Most of the growth slowdown [in per capita income]," states the Economic Report of the President, "can be traced to a slowdown of productivity growth."
Other industrial countries have also experienced a productivity slowdown, most even sharper, suggesting that worldwide forces rather than local ones are to blame. Despite two decades of speculation and study, however, the reasons for the worldwide productivity slump remain a mystery. A host of explanations have been proposed, including some that suggest that productivity growth is likely to revive spontaneously. Harvard economist Dale W. Jorgenson, for example, blames the sudden surge in oil prices in 1973, which he claims made much of the existing capital stock obsolete. His colleague Zvi Griliches points a finger at the slower growth of aggregate demand by consumers for goods and services, which, he argues, has kept a great deal of productive capacity idle and hence inputs underemployed. But Edward Denison, an emeritus fellow of the Brookings Institution who conducted a comprehensive analysis of seventeen suggested causes, has concluded that much, if not most, of the slowdown remains unexplained.
Most of the focus in recent years has been on three suspects:
One reason that investment received so much attention is growing evidence that countries with high productivity growth consistently save and invest more than countries with low productivity growth. Baumol writes: "A substantial part of the superior performance of Japanese growth in labor productivity may be ascribable not to increasing efficiency but to the accumulation of capital."
By the same token, British per capita incomes in the late nineteenth and early twentieth centuries, despite the industrial revolution's dramatic breakthroughs, grew at less than one-tenth the rate of lesser developed countries during the seventies. Not coincidentally, British investment back then was very low also. Similarly, in the United States the growth of productivity has been highly correlated with the growth of capital per worker. From 1959 to 1973, productivity grew by 2.8 percent a year while capital per worker in the private sector grew by 2.4 percent a year. From 1973 to 1989, in contrast, annual productivity growth of 0.9 percent coincided with growth of capital per worker of only 0.8 percent annually.
On the other hand, economists generally agree that most of the slowdown in productivity growth reflected factors other than investment, namely, a slowdown in total factor productivity.
2. Innovation. The rate of return to capital invested in research and development is very high, averaging more than 20 percent a year. But the United States spends a smaller fraction of its GDP on civilian R&D than Germany or Japan. And Zvi Griliches points out that the number of new patents granted each year began to decline as far back as the sixties.
Some economists think the spurt of productivity growth after World War II was due to the backlog of ideas and technology and investment projects that were put on hold during the depression and World War II. Pent-up consumer demand and the rebuilding of Japan and Germany, according to this thinking, created tremendous demand for new construction and equipment. This explanation is consistent with the decline in productivity growth that started in 1973. Thus, part of the decline may have been simply a return to more normal growth rates.
3. Skills. About 10 to 15 percent of the growth in productivity over the post-World War II era can be traced to more and better schooling. But average years of schooling have not increased since 1976, when it peaked at 12.9 years. Moreover, the quality of basic elementary and secondary education has stagnated or even declined in the past two decades.
Many economists focused in the 1980s on the apparently divergent behavior of productivity in manufacturing and in services. (The Bureau of Labor Statistics publishes separate measures of productivity in manufacturing despite Edward Denison's warnings that measuring productivity below the level of the economy as a whole is tricky.) From 1948 to 1973, manufacturing and services productivity grew more or less in tandem and then, from 1973 to 1979, stagnated in tandem. In the eighties productivity growth in manufacturing snapped back. Tougher foreign competition and deregulation led to a wave of mergers and acquisitions, which in turn led to plant modernizations and streamlined production processes. Productivity growth in services, by contrast, slowed even more in the eighties. Outside of manufacturing—from government to construction to retailing—productivity growth has come to a standstill despite huge investments in information-processing technology.
Some economists have concluded that industrialized countries are specializing in what they do best. While Japan and Germany have surged ahead in some industries, the United States has widened its lead in others and stayed ahead, if by a narrower margin, in still others.
Stagnating pay and greater income inequality have focused renewed public attention on slow productivity growth. Policy prescriptions range from tax cuts on capital gains and more deregulation to industrial policy and government backing for commercially promising technologies. Most economists support closing the federal budget deficit and maintaining low inflation because they believe a stable macroeconomic environment is good for productivity growth. But the major focus of current discussion is on how to raise investment in people and machines and how to get more bang for the buck from that investment.
Sylvia Nasar holds the Knight Chair in Journalism at Columbia University's Graduate School of Journalism. She was previously an economics reporter for The New York Times, a columnist for U.S. News and World Report, and an economics writer for Fortune.
Baumol, William J., Sue Anne Batey Blackman, and Edward N. Wolff. Productivity and American Leadership. 1989.
Committee for Economic Development. Productivity Policy: Key to the Nation's Economic Future. April 1983.
Denison, Edward F. Estimates of Productivity Change by Industry. 1989.
Economic Report of the President. 1990.
Economic Report of the President. 1992.
Mokyr, Joel. The Lever of Riches. 1990.
"The Slowdown in Productivity Growth: A Symposium." Journal of Economic Perspectives 2, no. 4 (Fall 1988): 3-97.