The Productivity Gap
The story of growth is productivity. Doing more with less. Before one can do more with less, one must learn. Thus, with experience comes productivity, particularly in a service-based economy. It is not a surprise that the proportion of experienced people in the workforce, particularly the 35-50-year cohort, provides a good description of productivity growth. If this is the case, then stories of secular decline are premature. In this environment, inflation can remain constrained and corporate profits rise as productivity increases, which is broadly supportive for equities and will mute bond yields.
Growth rates will accelerate modestly as the Millennial generation have an increasing impact on productivity.
Inflation may remain constrained as productivity moderates the increased demand.
Interest rates levels will not approach the prior cycle highs as lower population growth reduces the natural growth rate, and thus the expected interest rate.
Equity markets will benefit from the increased productivity of the workforce, particularly those that deliver domestic services.
The US will enjoy relative terms of trade advantages versus Europe and Japan and is US dollar bullish.
Exhibit 1. The Productivity Gap
Source: Penn World Table, Department of Health Services, Federal Reserve Economic Database, CRM calculations
These implications come with the time-worn caveats of economics: the past is not prelude, and everything else is held constant. Notwithstanding these caveats, demographic trends are unalterable forces that are only put asunder during a time of war. Barring that ominous outcome, it seems the most probable course for the US is modestly accelerating productivity.
The growth rate for the US has declined and is evident in the data (Exhibit 2). Annual growth in GDP for the US averaged 1.5% since the end of 2006, less than half of the 3.3% average for the 50 years preceding this period. Indeed, a decline in birth rate, an indirect component of GDP growth, should slow the growth, which is an outcome that Japan knows well. Even though population growth is not necessarily a determinant of slower growth (Pritchett, 1996), the fear for the US is that the aging workforce will contribute less to growth, while technology will not provide the boost of the past. Future growth does appear destined to slow when viewed through this lens.
Exhibit 2. US Real GDP Growth
Source: Federal Reserve Economic Database
In contrast, China is enjoying significant GDP growth while it’s population growth rate slows. The significant difference is productivity in China, whose GDP per capita is one third the level of the US. Indeed, China has room to increase productivity to the level of the US and will continue to move their workers up the productivity ladder towards the plateau that the US achieved. This process does not, however, explain slower US growth.
A critical determinant of the outcome is the battle between labor and capital. How the benefits of productivity growth is shared in crucial to economic growth, particularly for developed economies. While labor has the advantage of strength in numbers, is has the disadvantage of disaggregation that drives an inability to exercise a collective voice. Further, rapid changes in technology or trade patterns may obviate their skills. If their response as the terms of trade and technology evolve is inadequate, then they are left behind.
This outcome does not suggest that the US is locked in a spiral of declining productivity. Framing the debate in other terms, they US may be at the trough of modestly accelerating productivity. Demographics is argued as destiny and in this instance, the US has one of the most favorable outlooks in a world marred by demographic decline.
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Pritchett, L. (1996). Population Growth , Factor Accumulation , and Productivity. The World Bank Policy Research Working Paper, No. 1567(January), 44-44.