As the new U.S. administration takes shape, we can expect a lot of discussion on how to improve productivity as the driving force behind greater economic growth. Politically-minded writers will argue the removal of government regulations and the elimination of all interference in the free market economy is all that is needed to reverse the trends in productivity growth. Change the political environment and unleash productivity gains throughout the economy. However, there are serious underlying causes for the slowdown in growth, some of which may well be beyond the scope of public policy.

Initially, we have to look at two basic facts:

1. The slowdown is worldwide, especially in the developed economies. Average annual productivity growth—that is, the amount of output a worker can produce in an hour of work—has slowed to less than 1% in advanced economies over the past decade, roughly half the rate of the previous decade.( Chart 1). No one country has escaped this downward adjustment .

Chart  1.  

1. The slowdown has been underway for several decades.  Robert Gordon, the foremost economist in the area, has measured total factor productivity ( TFP) for the United States for over a century. (Chart 2). TFP determines how efficiently and intensely the inputs of both labor and capital are utilized in production. It goes beyond the familiar labor productivity estimates.

Chart 2       Annual Growth Rate of Total Factor Productivity by Decade, United States

Source: Robert Gordon, NBER

If there were a golden age of growth it would the period 1930-70. Since the 1970s the United States has experienced a general slowdown in productivity advances, although the trend has been broken, temporarily, in the 1990s. Since then productivity has barely exceeded 0.5 per cent annually. Combine this slowdown with the slowdown in the growth of the labor force results in an overall lower growth in potential GDP. How far we stray from the path of potential GDP is a measure of how much we underperform.

According to Gordon, there are four major headwinds that “are widely recognized and uncontroversial” that account for the productivity growth slowdown:

• Demographic changes that reduce the number of hours worked per person due to the retirement of baby boomers;

• The educational attainment of the American labor force has stagnated and falls behind those of many developed countries;

• Inequality in income distribution ; and

• Relatively high levels of debt to GDP at all levels of government.

One aspect behind the stagnation in productivity performance is the declining rate of net business investment. (Chart 3)

Chart 3   Ratio of Net Business Investment to Capital Stock

What is clear from the chart is that this decline has been underway for several decades, starting in late 1980's, and with the brief exception of the latter part of the 1990's, addition to capital stock been well below the average of 3 per cent yearly. The failure to deepen the stock of capital per worker is behind much of the overall decline in productivity.

Gordon places great emphasis on the role of innovation in driving productivity growth in the past, especially in those periods of rapid growth, such as 1920-70. However, he is less sanguine regarding the importance of current innovations (e.g. artificial intelligence and big data) in driving economic growth. Much of the low hanging fruits in innovation have already been picked. Generally, he concludes that productivity growth will continue on its current low trajectory.

So, we return to the issue of whether changes in the political environment will stimulate business investment. The equity markets, at the moment, seem to believe the faster growth is on its way. However, given the long history of declines in capital investment and the importance of innovation, the jury is out as to the impact of fiscal policy on changing the course of productivity growth.