Turning briefly to recent developments, the pattern of high employment growth and low productivity growth that we have seen in recent years has continued this year. So far in 2016, non-farm payroll gains have averaged about 185,000 per month — down from last year's pace of 230,000, but still more than enough to represent a continued improvement in labor market conditions. Estimates of monthly job gains needed to keep the unemployment rate steady range widely, from around 75,000 per month to 150,000 per month, depending on what happens to labor force participation among other things.
Output growth has been much less impressive. Over the four quarters ending this spring, real GDP is now estimated to have increased only 1-1/4 percent. This pace likely understates the underlying momentum in aggregate demand, in part because of a sizable inventory correction that began early last year; even so, GDP growth has been mediocre at best.
The combination of strong job gains and mediocre GDP growth has resulted in exceptionally slow labor productivity growth. Most recently, business-sector productivity is reported to have declined for the past three quarters, its worst performance since 1979. Granted, productivity growth is often quite volatile from quarter to quarter, both because of difficulties in measuring output and hours and because other transitory factors may affect productivity. But looking at the past decade, productivity growth has been lackluster by post-World War II standards. Output per hour increased only 1-1/4 percent per year on average from 2006 to 2015, compared with its long-run average of 2-1/2 percent from 1949 to 2005. A 1-1/4 percentage point slowdown in productivity growth is a massive change, one that, if it were to persist, would have wide-ranging consequences for employment, wage growth, and economic policy more broadly. For example, the frustratingly slow pace of real wage gains seen during the recent expansion likely partly reflects the slow growth in productivity.
Let me highlight a few topics from the growing volume of research on this topic. The first is that the productivity slowdown reflects mismeasurement, because the official statistics have failed to capture new and better products or properly account for changes in prices over time. Given how often we meet new technologies in our daily activities, even in classes of products that have been in operation for many years — from driving an automobile, to flying, to medicines and medical equipment, to our communications, and far more — it is easy to persuade ourselves that technological advances play a major part in improving our lives. However, some of these gains are conceptually outside the scope of GDP, and most recent research suggests that mismeasurement of output cannot account for much of the productivity slowdown.
Another explanation is that business investment has been relatively modest during the current expansion, and so increases in capital per worker have been smaller than in previous decades. Part of the modest pace of investment is likely because the effective labor force that will use this new capital has been expanding much less rapidly than in previous decades, but it is also possible that investment has been restrained by the subdued outlook for growth and profits, thereby generating less demand for expanding productive capacity.
However the slow growth in capital per worker has been quantitatively less important — accounting for only one-fourth of the slowdown in productivity compared with its long-run average — than the decline in the growth rate of total factor productivity (TFP), the portion of productivity that is not accounted for by measurable inputs to production. Indeed, TFP growth has averaged less than 1/2 percent per year in the past 10 years, well below its long-run average of 1-1/4 percent. Pinning down the exact causes of this slowdown is difficult, and there are many possibilities. For instance, it may reflect a slowdown in technological innovations, which may be persistent, as some have argued, or may be a temporary phenomenon, as I am inclined to believe.
Low-to-middling TFP growth might also reflect the downward trend in business dynamism, as evidenced by a notable slowdown in gross job creation and destruction. Diminished dynamism has been linked to a marked slowdown in the reallocation of labor and capital from low-productivity establishments and firms to high-productivity ones, especially in innovative sectors like high tech. Both phenomena are closely related to the declining trend in new business creation.
Are we doomed to slow productivity growth for the foreseeable future? We don't know. On the encouraging side, the technological frontier appears to be advancing rapidly in some sectors, and there are hints that the firm start-up rate is improving. On the more discouraging side, investment continues to disappoint — and so the current capital stock is smaller and embodies fewer frontier technologies than might otherwise be the case — and the productivity slowdown is a global phenomenon, suggesting that it may not be easily or quickly remedied.
Let me conclude by mentioning briefly one aspect of the low interest rate and low productivity growth problems — the fact that the Fed has been close to being "the only game in town," as Mohamed El-Erian and others have described it. At least one part of the solution can be found in the observation that overall macroeconomic policy does not have to be confined solely to monetary policy. In particular, monetary policy is not well equipped to address long-term issues like the slowdown in productivity growth. Rather, the key to boosting productivity growth, and the long-run potential of the economy, is more likely to be found in effective fiscal and regulatory policies. While there is disagreement about what the most effective policies would be, some combination of improved public infrastructure, better education, more encouragement for private investment, and more-effective regulation all likely have a role to play in promoting faster growth of productivity and living standards — and also in reducing the probability that the economy and particularly the central bank will in the future have to contend more than is necessary with the zero lower bound.
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