The Federal Reserve is extremely unlikely to raise interest rates at its meeting that concludes today, according to both financial markets and economists. The May jobs report that came out almost two weeks ago — showing a paltry increase of 38,000 jobs — probably killed any possibility of Fed action. But beyond their month-to-month concerns about the jobs numbers, a long-term worry is giving the Fed pause: weak productivity.
Productivity growth has slowed, and there is no sign that it will recover. From 2010 to 2015, labor productivity — which measures the amount of goods and services that a worker produces per hour — rose just 0.6 percent per year on average. That’s after averaging nearly 1.9 percent growth in the previous six years and 2.8 percent in the decade from 1994 to 2003. Productivity data is very noisy, but the long-term trend is clear: U.S. workers’ efficiency is no longer improving the way it did in the past.
Why might this be? Some economists claim that the most useful innovations — the low-hanging fruit for higher worker productivity — have already been developed. In this view, most prominently espoused by Northwestern University professor Robert Gordon, technologies like air conditioning, electricity and indoor plumbing did more to boost productivity than more recent innovations like computers or the internet. But that explains why productivity has slowed relative to 30 years ago, not why it’s down since before the Great Recession.
The decline in dynamism (the birth of startup companies, or movement from job to job) might explain the more recent productivity slump. The rate at which Americans start new companies has been falling in recent years. That may be because people are becoming more risk-averse or companies’ ability to expand has been curtailed.
In the long run, textbook economics says productivity is a crucial ingredient for economic growth. The innovation and investment that drive productivity higher lead to rising wages and living standards. Productivity is also key in determining the potential growth rate — how fast the economy can expand without triggering a self-defeating spike in inflation. The possibility of lower growth concerns the Fed because it affects how long interest rates must stay low to push the economy to its ceiling and help workers get jobs or see wage increases.
Janet Yellen, the Fed chair, noted last week in a speech that “labor productivity growth has been unusually weak in recent years” but said that she remains “cautiously optimistic” that it will rebound to normal levels. Productivity is devilishly difficult to forecast, however.
And there are some people who don’t believe the U.S. has a productivity problem. Silicon Valley technology boosters, for example, think productivity is higher than official government statistics say. After all, a stream of cutting-edge startups like Uber are reshaping entire industries. And looking to the future, the techno-optimists say that if some of the revolutionary technologies that are being developed — voice-recognition, computer vision, driverless cars — prove to be real and useful but the productivity statistics don’t budge, that will show there’s a measurement problem.
Economists are torn about whether our current productivity statistics accurately capture the changing nature of our economy. But new research backs up the old-fashioned statistics, affirming that the productivity slowdown is not an artifact of the data — it is real and even predates the recession.
And there’s another challenge for the Fed on the productivity slowdown: It seems to be global in scope, which suggests that any potential policies that could be employed to reverse the trend are beyond the Fed’s capabilities. Of 30 rich countries that belong to the Organization for Economic Cooperation and Development, 29 saw a slowdown in their productivity in 2005 to 2014, compared with the previous decade. To get productivity growing faster, economists recommend policies that promote research and development, as well as investment in infrastructure and education — all areas that are outside the purview of the Fed.
So although the economy is doing well in most respects, one reason the Fed is cautious about raising interest rates is because productivity growth is so slow.
For now, the Fed can only sit tight and hope that innovation picks up speed.