Surging US Productivity

WSJ takes a look at why US productivity is growing so rapidly – “The Labor Department reported Thursday that the productivity of the nation’s labor force — defined as output per hour worked by the average U.S. worker in the nonfarm business sector — rose at a breathtaking annual rate of 8.1% during the third quarter, following a 7% growth rate in the second quarter.”

Far more industries are benefiting from the productivity boom than most economists expected. Some had long argued that productivity growth was confined largely to the manufacturing sector, which could harness innovation to achieve greater efficiency in factories. And even within manufacturing — which makes up just 14% of the nation’s output — it was thought that technology-producing companies were responsible for much of the nationwide gains in productivity. Behind this view: the ability of the semiconductor industry to double the processing speed of computer chips every 18 months.

Much of the service sector, in contrast, was thought to be ailing from a condition called “Baumol’s Disease,” named after economist William Baumol. When he first wrote about the subject in the late 1960s, Mr. Baumol argued that productivity in large chunks of the service sector tended to rise more slowly than in manufacturing because services required more hands-on activity that machines couldn’t replace.

Mr. Baumol noted that a Mozart quartet would always require four musicians to perform and it would always last about as long as the composer originally intended. Lagging productivity, in turn, tended to push costs in services up faster than overall inflation.

While that was certainly true in the late 1960s, it’s starting to change now as technological advances allow service companies to do what electricity allowed manufacturers to do nearly a century ago — wring costs out of their operations by automating processes that used to require time and people.

In one completed in September, Brookings Institution economists Jack Triplett and Barry Bosworth found that service industries ranging from security brokerages to transportation services to law firms experienced sharply improved productivity-growth rates during the late 1990s. Even the health-care sector — a long and notable laggard — went from declining productivity between 1987 and 1995 to slight improvement between 1995 and 2001.

“It is the end of Baumol’s disease,” says Dale Jorgenson, a Harvard economist whose own work has found productivity trends improving in services. He says service companies in finance, retailing and trade have “become much more like factories” in search of inefficiencies that they can use information technology to eliminate. Mr. Baumol himself says computers may be helping services “more than the remainder of the economy,” though he adds education and health are still lagging behind.

Why is this all happening now? Erik Brynjolfsson, an economist at M.I.T. who has studied the behavior of individual firms, says U.S. companies made large investments during the 1990s, not only in technology, but also in a search for ways to reorganize themselves and adapt to a changing technological environment. Then, after the profit collapse, he says, executives intensified their efforts to harvest gains from those reorganization efforts. “We are getting the benefits of past investments,” he says.

A comment from John Robb on why this growth can be sustained:

1. The higher averages may mean that greater information flow is smoothing the productivity enhancement curve as well increasing the “sharing” of best practices processes across industry segments. That will yield a higher sustainable average over the longer term.

2. A large percentage of this increase in productivity growth is due to advances in information technology. So as Moore’s law marches on, we will continue to see this improve. Information technology is also supercharging other technology segments to plunge them onto their own rapid doubling rates.

3. Finally, the infrastructure for sharing information services (SOA and IT dial-tone) is being put in place across industry segments. This will make it possible to more quickly and fully realize the benefits of Moore’s law across all industry segements.

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Rajesh Jain

An Entrepreneur based in Mumbai, India.