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Picture of Christopher A. Hopkins, CFA

Christopher A. Hopkins, CFA

Slumping productivity taking dollars out of workers’ pockets

American workers aren’t as productive this year. According to the Bureau of Labor Statistics, nonfarm labor productivity has plunged the most since at least 1947. The third quarter improved slightly over Q2 but was still far below a year ago. The slump is troubling as labor shortages persist and the emerging hybrid work-from-home model endures its first sustained test under a normalizing covid environment. It also comes on the heels of a decade-long slowing of productivity improvement that already had economists concerned.

Labor productivity is a broad measure of how much economic value the average US worker creates. It is defined as the amount of inflation adjusted GDP per hour of labor and is a critical factor in the future growth of the economy and the real wages workers can earn. The slowdown is also contributing to current inflation as unit labor costs rose at a 3.5% annual rate in the third quarter despite less output per worker.

Productivity is the biggest single driver of economic growth. The sustainable rate of expansion in GDP is a function of productivity growth plus growth in the labor force, the sum of which equals total economic expansion.

It is no surprise that population growth is slowing. At the same time, the share of the population working or seeking work is contacting, suggesting that the labor force will grow by an anemic 0.4% annually over the next 10 years. With the government’s future estimate for productivity growth at 1.5% per year, this implies that GDP can only expand by 1.9% per year. Increasing legal immigration could help increase the work force and grow the economy but faces political opposition. The other variable, productivity, can be influenced somewhat more over the intermediate term.

Several recent factors may be at play to explain the recent productivity drop. With Covid lockdowns, millions were forced to work from home, triggering a brief spike in productivity as employers invested heavily on technology and workers paddled harder against the stream. Some of the slowdown may simply be a normalization from that temporary surge.

Burnout plays a role, as short-staffed employers have demanded more from current workers. We now know the psychological and physical health effects of covid are more pervasive than earlier believed. The viral phenomenon known as “quiet quitting” (perform only the bare minimum required for a job) may be one result. Meanwhile, excessive labor turnover prompted abbreviated cross training and assumption of unfamiliar tasks. And demographics certainly presents challenges as the workforce ages and some of the most experienced hands choose early retirement, taking important experience with them.

These and other factors may help explain the short-term collapse of productivity growth, but to understand the longer-term ebb, we must examine the main drivers of productivity over time: Technological development, human capital, and public investment.

Major technological breakthroughs are unpredictable but can spark surges in productivity. Obvious examples include disruptive catalysts like the steam engine, electricity, semiconductors, and the internet, but even more mundane innovations like indoor plumbing can drastically bend the productivity curve. Economist Robert Gordon likes to hold up pictures of an iPhone and a toilet and ask, “which one would you rather give up?” One never knows when the next game-changing innovation will emerge, but the likelihood increases with consistent commitment to the other pillars of human capital and public investment.

The US has been underinvesting in human capital for decades. In a large-scale 2018 international assessment of 15-year-olds administered by the OECD, US students ranked 30th out of 77 countries and near the bottom of all industrialized nations in math skills. While the US may lead the world in student testing, our relative achievement has barely budged since the first OECD assessment in 1967. On the college front, the situation is hardly better. Between 2008 and 2018, state support for higher education declined by 13% per student while the cost of tuition has doubled, leaving graduates more indebted but no better prepared. Clearly, more emphasis on and funding for two-year colleges and non-college technical training programs could also help shift the productivity curve and provide a greater return on investment.

The third factor driving productivity growth is the level of public investment in infrastructure and R&D. Some essential programs are too big and costly or have a payoff too far in the future to attract private capital. Yet the return on private capital is heavily dependent on a robust infrastructure financed by public (i.e., taxpayer) investment. Many years of insufficient financial commitment has placed us at a competitive disadvantage and retarded productivity growth. For example, while it is well known that our transportation infrastructure needs substantial upgrading, we invest less that one tenth as much of our GDP as China does on transportation.

Ironically, the return on public investment is huge. Several economic analyses have suggested a multiplier of around 3, meaning that the US economy expands output by $3 for every $1 of public investment, and that on average public infrastructure investments yield higher rates of return than private capital projects. Just as in private enterprise, capital investment is a necessary condition for expansion and income growth in the public sphere. Having neglected this imperative during the era of low interest rates, catching up will now be costlier and require more difficult tradeoffs in budgeting priorities, but failure will ensure slower growth and a diminishing living standard into the future.

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