October 2002
Productivity in the Twenty-first Century
At an AEI and Department of Labor conference held on Wednesday, October 23, 2002, leading academics, economists, government officials, and chief executives discussed productivity in the twenty-first century. During the late 1990s, productivity soared and ignited a "new economy" debate over whether the phenomenon was temporary or permanent. More recently, productivity growth has been unusually strong in the face of an abruptly slowing economy, surprising many skeptics who viewed the productivity boom of the 1990s as a temporary blip.
Welcoming Remarks
Elaine L. Chao
U.S. Secretary of Labor
At this time of year the discussion of the economy has been reduced to ten-second sound bites, so it is especially important for this conference to address the impact future productivity growth has on the economy. America's productivity has given us the highest standard of living in the world, and a strong competitive advantage that no other country can match. Productivity growth is critical in maintaining and improving the standard of living of America's workers and it is especially important to me as secretary of labor.
Since 1947, real hourly compensation and productivity have tripled, and even in the past seven years our nation has expanded rapidly without inflation. Productivity growth has also held up well since 2000. In the past five quarters we have seen a 3.8 percent increase in productivity, which is stronger than in any economic downturn since 1969. These numbers are solid and highly encouraging. Comparatively, annual productivity growth from 1973 to 1995 was 1.4 percent.
While we do not understand all the factors that cause productivity growth, today we will explore relationships between economic factors and productivity. Some argue that productivity growth comes at the expense of workers, but we have not seen this in the past decade.
It is important for us to explore the impact productivity growth has on safety and technology. Many companies have shown that a safer workplace and more efficient use of technology increase productivity.
Today's workforce is the most educated workforce ever, with one-third at least possessing bachelor degrees. Additionally, the workforce has become increasingly diverse with larger numbers of women and minorities. Another key question is whether the Internet can stimulate productivity growth further. Perhaps stimulating education and training will help workers better utilize new technologies.
Productivity growth is more important to the American economy than ever. A 1 percent increase in the productivity growth rate could cut the federal deficit by two trillion dollars in ten years and cut the Social Security shortfall by one-fourth to one-half in seventy-five years. The human side of the productivity equation is even more important because it concerns jobs and workers. Productivity growth is key to our future and determines the standard of living for the next generation of America's workers.
Panel I: Is There a Productivity Miracle?
What can account for the rapid, yet sustained, increase in America's productivity? How much of the increase can we attribute to advances in and the increased use of information technology? This panel addressed these questions as well as the larger one of whether or not there is a productivity miracle.
Kathleen Utgoff
Bureau of Labor Statistics
When the Bureau of Labor Statistics (BLS) measures productivity increases it compares the change in output against the change in the total number of hours worked. This method gives a rate of productivity growth, not a level. The BLS commonly excludes the government and nonprofits because their output is currently not quantifiable. The farm sector is also excluded because its output is too volatile.
Using this common measure, one can see that in the post-World War II period, the U.S. economy has averaged 2.5 percent productivity growth in periods of expansion, which has been offset by a relatively slow growth rate of 0.8 percent during recessions. However, from 2000 through the second quarter of this year, which includes the last recession, the rate was 2.8 percent.
This remarkable productivity increase is largely a result of advances in information technology. This is not to say that the productivity increase has been confined to offices. Of all the manufacturing sectors, only transport was less productive in the period from 1995 to 2000 compared to the period from 1990 to 1995.
R. Glenn Hubbard
Council of Economic Advisors
No single policy issue is more important than identifying where the productivity miracle comes from and how we can extend it. To illustrate this point, the two-tenths difference between a 3.1 percent and 2.9 percent rate of productivity growth over the next ten years would be worth roughly an extra $1,000 to every man, woman and child in America.
To explain why the United States has experienced such rapid productivity growth we need to look beyond the impact of technology. International comparisons prove that these are not sufficient explanations. The United States does not possess enough proprietary technology information to account for the differences between the United States' rapid rate of productivity growth compared to the anemic rates of our European rivals. This leads to the conclusion that something other than advances in information technology, and its use, accounts for at least some of the acceleration of overall productivity growth. The difference can be linked to our unique economic environment that includes our institutions, regulations, and general market structure. Therefore, a neutral environment that allows for free-flowing capital and labor, continued sensible deregulation and intelligent tax-policy reform could all have a positive impact on future productivity growth. Improvements to this fragile framework could lead to extraordinary gains, but any changes need to be undertaken with caution so as to avoid unintended harmful consequences.
To fully identify the source of our productivity growth, we need to look beyond the normal economy-wide studies. Therefore, we should closely examine both the types of competition as well as the practices of successful corporations. Their management, organization, and human resource styles can offer insights into how we can further improve American productivity.
Steve Oliner
Federal Reserve Board
What follows is not an official Federal Reserve forecast nor are the numbers official Federal Reserve numbers.
The new economy is very much alive. Revival is well, but we need to distinguish the fairy tale economy from the real one. In our paper we used a standard growth-accounting model to look at the economy from 30,000 feet. In the model we broke down labor-productivity growth into contributions from computer hardware, software, communications equipment, and other capital. Furthermore, we looked at changes in productivity growth where the inputs remained constant, but the output increased.
Two factors were found to be very important to the acceleration in productivity growth in recent years. The more obvious of the two to the public is the ongoing huge investment in technology for the workplace. Alongside this technology, producers have experienced large efficiency gains, especially in the semiconductor sector.
The key issue facing the economy is whether this pace of technological advancement can continue. While we cannot predict with certainty, the indications are positive. Firms are continuing to purchase information technology products at a constant or accelerating rate and the historical record also indicates that as technology changes become older, they become more prevalent. Therefore, our outlook, while only good for five to ten years, is very optimistic. We predict, in line with other analysts, a rate of productivity growth of 2 to 2.75 percent over that period.
Frank R. Lichtenberg
Columbia University
The research and development primarily associated with the life sciences was in 1996 approximately 16 percent of total United States research and development, including military. A significant portion of this was and still is directed towards the creation of new drugs. These new drugs can increase per capita productivity three ways: increased ability to work, increased longevity, and a decrease in the use of other, more costly, medical services.
One can test the first way that new drugs increase ability to work because there are some medical conditions for which many new drugs have been introduced and others for which relatively few new drugs have come to the market. Using this data, a strong negative correlation has been shown between the increase in the number of new drugs available for a condition and the number of workers unable to perform their jobs due to that condition. The estimates show that the new drugs introduced since 1983 have reduced by 98.9 million per year the number of missed workdays. If those days are valued at $100 each, then the savings are worth $9.9 billion a year.
The second path is increased longevity due to new drugs. Increases in longevity lead to an increase in potential leisure time. Since one's welfare depends both on leisure time and goods, an increase in longevity can greatly increase one's welfare. Traditional measures of per capita GDP growth tend to underestimate these effects. Consequently, true welfare, as measured by per capita GDP, can be said to have increased by as much as 50 percent more than originally thought.
New drugs can also increase productivity by reducing the use of other medical costs. Though new drugs are more expensive, people who use them tend to use fewer nondrug medical services such as hospital stays or doctors visits. This reduction in nondrug costs saves roughly four times as must as the increased costs from using new medications.
Panel II: Productivity and Jobs
Three scholars and two CEOs addressed the relationship between productivity growth and jobs and demonstrated the positive impact that productivity growth can have on the job market.
Martin Baily
Institute for International Economics
It appears that the acceleration of productivity growth from approximately 1.5 percent in the 1970s, '80s, and '90s to approximately 2.5 percent in the late '90s and early '00s will continue, because this acceleration seems to be structural, rather than cyclical. Though many people mistakenly believe that information technology (IT) development is the main factor in productivity growth, it is usually the case that many different factors, in which IT is only one, create healthy productivity growth. Some IT developments have even been problematic, slowing down progress because of the manner in which firms can become locked in to certain software. Productivity growth flourishes best in a highly competitive environment with good regulation, but not no regulation. Europe, for example, has seen greater productivity growth than the United States in the telecom sector owing to its better, though still imperfect, regulation of the industry. Productivity growth seems to be correlated to decreasing unemployment rates, which seems logically sound, though there is little empirical evidence to show a causal relationship.
Jared Bernstein
Economic Policy Institute
During the 1990s, the economy saw gains in productivity growth accompanied by a fall in unemployment. This challenged the notion that productivity growth and rising unemployment went hand in hand, even suggesting that increased productivity growth could actually reduce unemployment in the long run. At this point, despite the statements from the Congressional Budget Office and a variety of economists, there appears to be little evidence that the Non-Accelerating Inflation Rate of Unemployment (NAIRU), the level of unemployment at which inflation remains stable, must be 5 to 6 percent when productivity growth is at the current level of 2 percent. There is strong evidence that NAIRU could be closer to 4 percent.
There are differences between this productivity growth and examples from the past. One of the significant ones is that in the 1980s boom, low-wage workers' real wages remained flat with 8 percent productivity growth, but in the 1990s boom, low-wage workers' real wages rose significantly with 15 percent productivity growth.
Edmund Phelps
Columbia University
Despite the assumptions, particularly in Europe, that productivity growth leads to higher unemployment rates, as machines and computers replace people, the evidence points to quite the opposite phenomenon: Faster productivity growth dissolves unemployment while slowdowns in productivity growth can lead to increases in unemployment. Furthermore, even the expectation of booms in productivity growth can positively impact the job market as employers tend to hire in expectation of greater productivity.
Dick Davidson
Union Pacific Corporation
In 1944, Union Pacific (UP) had over 1.7 million employees. In 2002, that number is closer to 250,000. This is largely due to productivity growth and technological advancement. Developments such as unmanned cabooses, global positioning satellites, and fiber-optic cables allow UP to vastly increase its productivity. In the last two decades, UP has seen a 650 percent increase in worker productivity, as their figures now show a level of twenty gross-ton-miles for each employee, as opposed to less than four in 1980. Davidson noted that privatization can have a huge impact on productivity, pointing to the Mexican railroad industry as an example, where worker productivity increased by 1700 percent in the years following the privatization.
Marilyn Carlson Nelson
Carlson Company
The Carlson Company has recently seen a sharp increase in productivity, despite having stable investment in IT, having recently trimmed the staff from over 50,000 to just under 39,000. Such cutbacks are a natural and often necessary step to trim fat from bloated organizations that have low levels of worker productivity. Much like continuing education courses for workers, such rises in productivity have the added benefit of raising worker morale. Higher productivity also breeds greater competition, creating demand for workers elsewhere in the industry.
Luncheon Address: "Productivity in the Twenty-first Century"
Alan Greenspan
Federal Reserve
Chairman Greenspan identified factors that have contributed to this productivity and offered his expectations for the future.
The primary reason for the productivity feast of recent quarters has been companies' actions to cut fat that accumulated during the long expansion of the 1990s. During this period, management was focused primarily on the perceived profitability of expansion and less on the increments to profitability that derived from cost savings. Managers are now trying to identify and eliminate those redundant or nonessential activities that accumulated during the boom years.
The other reasons for growth in productivity include effectively using capital with active secondary markets such as computers and networking equipment; employing the existing workforce more intensively; and returning to a low inflation environment. Yet these are secondary explanations because ultimately the quantity of fat in the system and the opportunities for productive reorganization will determine the potential gains in productivity. Yet there are limits to the amount of output that can be produced from an existing facility, even in the short run, no matter how intensively it is employed and how much fat is taken out of the system.
Arguably, the increase in productivity growth since 1995 largely reflects the ongoing incorporation of innovations in computing and communications technologies into the capital stock and business practices. Indeed, the transition to the higher permanent level of productivity associated with these innovations is likely not yet completed.
Despite the difficult recent economic adjustments, and the uncertain future, it is both remarkable and encouraging that despite all that has transpired over the past couple of years, a significant step up in the growth of productivity appears to have persisted.
Panel III: The Future of Productivity
The nation's economic future undoubtedly depends to a great degree on the path of future productivity. Which policies might best set the stage for a continuation of the positive productivity experience? Are there good reasons for optimism about continuing productivity? A panel of corporate CEOs and federal government leaders discussed the future of productivity.
J. T. Battenberg III
Delphi Automotive Systems
When a company focuses on safety, quality and productivity will follow. At Delphi, we discovered that an injury- and illness-free workplace was an attainable goal. Striving to be a leader in safety is the right thing to do for the company and the employees, but getting there is a long journey. Improving health and safety measures requires a culture change. Nothing we do to improve quality is worth getting hurt or jeopardizing safety.
From 1999 to 2001, lean transformation at Delphi resulted in productivity growth: The ratio of hours worked per $1,000 revenue improved by 30 percent (about 10 percent per year). Having healthy employees who were not injured increased productivity. Quality and health move in tandem with one another--when one increases, the other does as well. Employees must see that quality and health go together. While employees view productivity goals as suspicious, they do not view health and safety goals in the same way. Delphi had to work with both managers and the unions to enact this change in company culture.
Greg Bentley
Bentley Systems
The United States' software industry provides two applicable lessons for broader public policy to maintain the most fertile environment for sustained productivity improvement. The first lesson is that open, two-way trade pays off. Software's relatively favorable trade regime has been crucial in enabling it to flourish, to everyone's advantage. Based on the latest figures, the packaged software industry's trade surplus grew from $13 billion in 1997 to over $22 billion in 2000. As software distribution gravitates entirely to the borderless online environment, everyone in the world who stands to gain from America's continued research and development has a stake in making sure that trade remains free while intellectual property remains protected.
The other policy lesson from software's success is the virtue of avoiding regulatory shackles, which in the case of information technology was accomplished somewhat fortuitously as a consequence of constant, rapid change. For example, the world's agreement on a moratorium on taxation of the Internet seemed unlikely until recently.
Phillip J. Bond
Department of Commerce
Productivity growth is reliant on technology. The speed with which companies adopt new technology faces several challenges. The gap between best-in-class technology and average technology continues to grow. Creating new jobs does not instantly increase productivity. Most new technology is not plug and play, but rather requires substantial training for workers to fully utilize. Current education and training programs are not using the full capabilities of technology. Inadequate technology training, particularly in public schools, poses a significant challenge to the nation's long-term productivity. America needs radical new changes in the adoption of new technologies in education.
There are some positive developments for productivity in technology. The United States still leads the world in technology and telecommunications productivity. The coming generation has grown up with technology. Ninety percent of American children between ages nine and fifteen have used computers. That can only be good. An increasing seriousness about e-government and more e-commerce activity among small businesses also are helping boost productivity.
A fundamental challenge is going to be achieving and sustaining productivity by becoming a nation of lifetime learners. This is going to be challenge for all of labor, all of commerce, and all of education.
Henrietta Holsman Fore
United States Mint
Both time and money are valued quite differently in government. So we measure everything by cycle time, the period in which the Mint manufactures and delivers its products. How do you measure a government agency, because we do lots of things other than just output? We are dealing with public education. We are also dealing with legislative requirements and budgetary requirements and reporting requirements. How do you rate and benchmark the effectiveness of our security operations? Right now we measure them based on the level of threat and our readiness at our places of operation. The United States Mint continues to refine performance objectives and performance outcome measures and to define new measures that are more relevant to our operations. Goals include reducing employee lost time for workplace accidents and injuries, reducing the time required for manufacturing and delivery cycles for our coins and other products, and increasing customer satisfaction. In the last year, we have realigned and streamlined our business lines and have implemented new processes to improve our manufacturing cycles.
The challenges to reaching our productivity objectives revolve around our workforce. We not only need to raise the skills of our workforce, but also focus on flexible skills. Employees' quality of life is very important. We emphasize a culture based on a multifaceted value system: accountability, leadership, trust, respect, integrity, and teamwork.
George Halvorson
Kaiser Foundation Health Plans and Hospitals
Right now we are facing an explosion of healthcare costs in this country. Current cost trends are exceeding all recent cost trends and they are not likely to reverse in the near future. We also have an aging population, and there is a very steep increase in the rate of healthcare use when people get into their fifties. The healthcare delivery system is not a particularly well-designed system; in fact, it's an undesigned system. The inconsistency in treatments that exists among physicians is massive. Physicians are also typically working in an antiquated, totally nontechnological environment with incomplete paper medical records.
A possible solution to these challenges is automation of medical records. Electronic records reduce paperwork and cut down on administrative costs. Currently a very high percentage of the healthcare dollar goes toward various levels of paperwork, claims filing, and administrative issues. Without electronic records, we are not going to reengineer healthcare and get it to levels where the productivity resembles what we need to see. Privacy issues are significant obstacles to electronic patient records, but the bigger issues are the fact that the healthcare delivery system is such a splintered system and has so many independent moving parts with none of them interrelating to each other.
AEI research assistants Peter Brownfeld, Sean Gupta, Jeremy Kadden, Eric Krause, and Sharon M. Utz prepared this summary.
