Productivity, Growth, and Cost

In the year 2000 Alan Greenspan looked to improved productivity as the reason the economy was so good:

In the last few years it has become increasingly clear that this business cycle differs in a very profound way from the many other cycles that have characterized post-World War II America. Not only has the expansion achieved record length, but it has done so with economic growth far stronger than expected. Most remarkably, inflation has remained largely subdued in the face of labor markets tighter than any we have experienced in a generation.

A key factor behind this extremely favorable performance has been the resurgence in productivity growth.

Stands to reason. If we produce more per hour than we used to, and nothing else changes, then output will go up.

Yet only a couple years later, Greenspan was puzzled. Productivity growth was impressively good, but economic growth was not:

The increase in nonfarm business output per hour over the past year will almost surely be reported as one of the largest advances, if not the largest, posted over the past thirty years. We at the Federal Reserve, along with our colleagues in government and the private sector, are struggling to account for so strong a surge. We would not be particularly puzzled if the increases in output per hour were occurring during a period of very rapid economic growth, such as has often attended recoveries from steep recessions... But during the past year we averaged only modest economic growth.

Evidently, productivity growth is not the whole story when it comes to economic growth.

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In the latter speech, Greenspan said

From an average annual rate of 1-3/4 percent in the late nineteenth and early twentieth century, it jumped to a 3-3/4 percent rate in the decade following World War I. Subsequently, productivity growth returned to a 1-3/4 percent pace. Then, for the quarter century following World War II, productivity growth rose to an average rate of 2-3/4 percent before subsiding to a pace of 1-1/2 percent annually from the mid-1970s to the mid-1990s.

And then, looking back over the latter 1990s from his 2002 perspective:

Over the past seven years, output per hour has been growing at an annual rate of more than 2-1/2 percent, on average, compared with a rate of roughly 1-1/2 percent during the preceding two decades.

It seems that good productivity and a good economy go together. Productivity was good in the Roaring '20s, and in the Golden Age following World War Two, and again in the boom years of the latter 1990s. Sure: Productivity drives economic growth. But that isn't the whole story. Economic growth also drives productivity.

Apparently, the state of the economy affects our ability to use technological advance to improve productivity. The Great Depression, for example, was a time when improved technology failed to feed into productivity and growth; in a footnote, Greenspan says:

In contrast to the boom in productivity after World War I, which many economists associate with a few key innovations, analysts usually ascribe the post-World War II boom to innovations in many sectors reflecting the diffusion through the private economy of (a) new technologies that appeared in the 1930s but were not fully implemented during the Depression, and (b) a gradual application to civilian activities of military-related innovations.

"New technologies that appeared in the 1930s but were not fully implemented during the Depression". So it seems that two things are true:

1. Improved productivity leads to an improved economy; and
2. A declining economy leads to declining productivity.

How can this be? If productivity is pushing the economy upward, how can the economy be pushing productivity down? Obviously there is more to the story. If productivity pushing the economy upward meets resistance, it is likely that something else is pushing the economy down, offsetting or undermining the effects of improved productivity.

Greenspan says lower costs are associated with improved productivity: "On a consolidated basis for the corporate sector as a whole, lowered costs are generally associated with increased output per hour."

I say that higher costs are associated with declining productivity.

Excessive financial cost pushes our economy down. It pushes productivity down.