Wednesday August 4 1999 Financial Times Euro European Performance League Not so new economy Managers from Mars Comment / Columnists Not so new economy Computers may have revolutionised the workplace, but they have not had much impact on productivity in the US The US economy of today is unquestionably new. But that newness is not news. Ever since modern economic growth began, the sole constant has been change. Those who insist that things are different this time - to justify perhaps the most highly valued stock market of the century - need to show that the economy is new in a new way. So what might be new about today's economy? There are several possibilities. But the most important for the market is the proposition that productivity growth has been transformed for the better. While such an improvement would not itself be sufficient to justify the extraordinary stock prices, it would be a necessary part of such a justification, since higher productivity growth also means higher economic growth in the long run. Yet since the present expansion began, in the first quarter of 1991, output per hour in the US non-farm business sector has risen by only 1.6 per cent a year. This is a little faster than the 1.3 per cent a year since the last quarter of 1973. But it is well below the 2.6 per cent a year achieved between 1953 and 1973. At best, the post-1991 improvement seems a modest reversal of the still-unexplained post-1973 productivity growth collapse. To describe this as "new" is to stretch the meaning of the word beyond breaking point. If there is anything new, it has to be still more recent. That is what Alan Greenspan, chairman of the Federal Reserve, argued in his Humphrey-Hawkins testimony on July 28. "That American productivity growth has picked up over the past five years or so has become increasingly evident," he argued. "Non-farm business productivity (on a methodologically consistent basis) grew at an average rate of a bit over 1 per cent per year in the 1980s. In recent years, productivity growth has picked up to more than 2 per cent, with the past year averaging about 2= per cent." In explaining what is going on, Mr Greenspan noted that "output has grown beyond what normally would have been expected from increased inputs of labour and capital alone. Business restructuring and the synergies of the new technologies have enhanced productive efficiencies." This is an appealing story. It is what US business believes, not to mention equity investors. But is it true? Robert Gordon of Northwestern University, one of the foremost experts on US growth performance, has analysed just this question.* He does find that growth in output per head since the last quarter of 1995 "has recovered more than two-thirds of the productivity growth slowdown registered between" 1950-1972 and 1972-1995. Thus between the last quarter of 1995 and the first quarter of this year, non-farm output per hour rose at an annual rate of 2.2 per cent. This is not far below the 2.6 per cent of the period between 1950 and 1972, and far above the 1.1 per cent of the period between 1972 and 1995. Yet Professor Gordon also argues that all of this productivity rebound can be explained by three factors: improved measurement of inflation; the response of productivity to the exceptionally rapid output growth of the past few years; and the explosion of output and productivity in the production of computers Big efforts have been made in recent years to improve the accuracy of measures of US inflation, to allow properly for quality improvement, which has been underestimated in the past. For any given growth in money gross domestic product, lower estimates of inflation necessarily mean higher growth of real output and so productivity. Equally, this has been an unusual business cycle, with a sluggish beginning, followed by a strong acceleration. Output growth was only 2.6 per cent a year between the first quarter of 1991 and the fourth quarter of 1995, but 3.9 per cent a year thereafter. Since productivity is always strongly affected by output growth in the short term, the productivity acceleration was inevitable. Of the 1 percentage point improvement in productivity growth in non-farm private business since 1995 (in comparison with 1972-1995), professor Gordon concludes that 0.3 percentage points are explained by the recent cyclical acceleration in growth and 0.4 percentage points by the improvement in measurement of inflation. This leaves a structural improvement in productivity growth of just 0.3 percentage points a year, all of which is explained by productivity improvements in the manufacture of computers alone. Productivity growth in the production of computers has risen from 18 per cent a year between 1972 and 1995 to 42 per cent a year since 1995. This, argues professor Gordon, explains all the structural improvement in productivity growth in durable goods as a whole, from 3.1 per cent a year between 1972 and 1995 to 6.8 per cent a year thereafter. The computer has brought about a productivity miracle - in the production of computers. A tail can wag a dog, if it wags hard enough - this is what the dramatic improvement in the productivity of computer production has achieved. How can all the investment in computing have so small an impact on productivity in the rest of the economy? The answer is suggested in a paper by Dale Jorgenson and Kevin Stiroh, of Harvard University and the Federal Reserve Bank of New York, respectively.** The fundamental point is that computers have simply substituted for other inputs, particularly other forms of capital. Growth in computer inputs exceeded those in other inputs by a factor of 10 between 1990 and 1996. Yet substitution of one form of capital for another need not raise productivity in the economy as a whole. The fundamental measure of technical progress is "multifactor productivity" - the increase in output per unit of all inputs. The question about the computer revolution is not whether there has been technical progress in the production of computers, but how far this has spilled over to the other 99 per cent of the economy. The evidence is that it has not. The chart below, taken from another paper by professor Gordon, places recent performance in the context of what he calls the "long wave" in technical progress.*** This reached a crescendo in 1950-64, before subsiding. His explanation is that the inventions of the late 19th century and early 20th centuries were far more fundamental sources of economy-wide productivity improvement than the electronic/internet era of today. What were those improvements? They were electricity; the internal combustion engine; chemicals; and communications/ entertainments (radio, television and films). Remember that computer manufacture accounts for 1.2 per cent of the US economy. Computers also accounted for only 2 per cent of the capital stock at the end of 1997: businesses may indeed be spending a vast amount on computers, but largely to replace old ones. Underlying productivity performance today may be a little better than in the two decades after the first oil shock. But this performance remains far from that of the pre-1973 golden era. If the economy is new in a new way, as the optimists argue, it is not in productivity that this brave new world is, so far, to be found. * Has the New Economy Rendered the Productivity Slowdown Obsolete? June 1999 - see external links ** Information Technology and Growth, The American Economic Review, May 1999 ***US Economic Growth since 1870: One Big Wave? The American Economic Review, May 1999 Contact Martin Wolf by e-mail on [EMAIL PROTECTED]
