Economists will tell you that there are only two ways to grow an economy: increase the number of people working (or more accurately, the aggregate number of hours worked) or improve the productivity of the existing work force (output per hour worked). That equation is simple enough. If there are fewer people in the country working, they must be more productive in order to generate the same amount of “stuff”, which includes goods and services. Conversely, if the working population is growing at robust rates but the work force is less productive as a whole, the decrease in productivity will offset the benefits of a larger labor force.
I’m sure everyone has seen the media stories in recent months about how birth rates in the US and other advanced economies have plummeted in recent years. In fact, the CDC data says that the number of births in the US was down 4% in 2020, representing the largest decline in the past 50 years. The 2020 US fertility rate, which is the number of births per 1,000 women aged 15-44, was just 55.8 – a new record low. The pandemic obviously has something to do with the decline in births last year. After all, who wants to start or expand a family when their personal health and economic situations are in such a state of uncertainty. But the drop in birth rates in 2020, while anomalously large, was also just the latest data point in a long downward trend. A May 5th Associated Press article by Mike Stobbe read, “The U.S. once was among only a few developed countries with a fertility rate that ensured each generation had enough children to replace it. About a dozen years ago, the estimated rate was 2.1 kids per U.S. woman. But it’s been sliding, and last year dropped to about 1.6, the lowest rate on record.”
The drop in the US birth rate could have profound economic implications. Combined with the waves of baby-boomer retirements and stricter immigration policies, a declining birth rate will place a greater onus on labor productivity in determining future rates of domestic economic growth. But the problem is that productivity rates are generally unpredictable and usually tied to the widespread adoption of some new game-changing technology. For example, labor productivity grew at a 3.0% annualized rate from 1996 to 2005 as the myriad productivity benefits associated with the internet took effect. Thereafter, from 2006 to 2019, productivity growth averaged a paltry 1.6%.
Boosting future rates of labor productivity without relying on unpredictable technological innovation requires the kind of investment that has been deferred for the past several years. Neither corporate America or government entities have been investing at the rates necessary to be more competitive in a global economy. Businesses have, by and large, been using growing profits and tax windfalls to buy back stock rather than making large-scale capital investments. Banks have been hoarding capital due to more onerous regulatory requirements, a relative lack of loan demand, and general skittishness about the economic outlook. Federal and state governments, deeply in red ink as a result of tax cuts and the emergency responses to both the Global Financial Crisis and COVID-19, have neglected the kinds of investment necessary to boost productivity. US educational standards have dropped and our infrastructure is in a sad state of disrepair. We have also fallen well behind in emerging industries such as renewable energy and critical supply-chain components such as semiconductors and rare-earth metals. Chronic health conditions like obesity and opium addiction are endemic. Foregone investments in each of these areas are one reason for the declining rates of productivity we’ve seen in since the GFC.
But more recently, productivity growth has been picking up (albeit from very low levels). Labor productivity rose 2.5% in 2020 and was up 4.1% in the first quarter of 2021. Productivity figures can bounce around a lot, especially during times of economic volatility, but the improvements are nonetheless encouraging after so many years of weakness. Some of the improvement may have been the result of companies using fewer workers to produce the same level of output during COVID. But there could be more sustainable sources for the improvements as well. Most obviously, the trend toward working from home (WFH) and the widespread use of videoconferencing could be freeing up time for workers to become more productive. There are undoubtedly many other factors contributing as well.
An added benefit of higher productivity growth is that it can boost wages without a commensurate increase in more widespread inflationary pressures. And if wages are growing faster than price levels, we can also expect to achieve every politician’s dream – sustained improvements in living standards. For the better part of the last 25 years, stagnant inflation-adjusted incomes combined with rising costs for non-descretionary items (food, energy, child care, health care, education) have been squeezing the middle class. The disenfranchisement of large portions of the middle class has led to the increased support for populist economic policies and increased political polarization we’ve witness over the past several years. These are not good trends. In recent years I’ve shared the following chart in the presentations I’ve given to various groups. Starting at the top and working your way around clockwise, you can see that the our present course is not a sustainable one.
Let’s hope the recent trend of productivity improvements is just the beginning. The holy grail of rising middle-class incomes without more widespread inflationary pressures would be a very welcome development for our economy, our markets, and our political discourse.