Image Source: PixabayOver time, a rising US standard of living is driven by productivity growth. Michael Peters succinctly describes the problem in “America Must Rediscover Its Dynamism” (Finance & Development, September 2024). He writes:
The US economy has a multitrillion-dollar problem. It’s the dramatic slowdown in productivity growth over the past couple of decades. Between 1947 and 2005, labor productivity in the US grew at an average annual rate of 2.3 percent. But after 2005, the rate fell to 1.3 percent. Such seemingly small differences have astonishingly large consequences: if economic output for each hour worked had kept expanding at 2.3 percent between 2005 and 2018, the American economy would have produced $11 trillion more in goods and services than it did, according to the US Bureau of Labor Statistics. This is part of a broad-based trend across advanced economies. Productivity growth in Europe has been even slower than in the US. As a consequence, Europe has fallen significantly behind the US in terms of GDP per capita. Productivity is a key driver of economic expansion.
What are the main drivers of this problem? Peters argues that advances in information technology are linked to economies of scale: that is, big companies are best-positioned to take advantage of new information technology, which makes dynamic entry from small- and medium-sized firms difficult. As a result, the main productivity gains information technology are accruing primarily to big firms, rather than diffusing through the economy. Peters writes:
In discussing the productivity dynamics of the 1980s and 1990s, the advent of IT is the elephant in the room. Could the availability of such technologies have caused the decline in dynamism and the peculiar boom-bust shape of productivity growth? Two recent papers argue that the answer is yes and that economies of scale play an important role. French economist Philippe Aghion and his research collaborators (2023) posit that advanced IT makes it easier for businesses to scale their operations across multiple product markets. The London School of Economics’ Maarten De Ridder (2024) argues that IT allows enterprises to reduce their marginal costs of production at the expense of higher fixed costs.
What these explanations have in common is that the adoption of such technologies is particularly valuable for productive companies. This implies that such businesses took advantage of IT developments in the late 1980s and early 1990s, and the economy experienced an initial productivity boom. More surprisingly, the researchers argue that the existence of these megabusinesses can have dynamic costs in the long run. If new businesses (such as a new IT start-up) expect that they will have a hard time competing with existing enterprises that produce at scale (such as Amazon, Microsoft, or Google), their incentives to enter the market shrink. As a result, overall growth and creative destruction can decline, and incumbent companies benefit by charging higher markups. …
A separate strand of research suggests that the process of knowledge diffusion among businesses has changed in fundamental ways. In particular, the argument goes, in recent decades technologically lagging companies had a harder time adopting technologies of competitors at the productivity frontier. This change could be technological in nature: companies such as Google or Apple may be so technologically advanced that adoption simply becomes impossible for smaller rivals. At the same time, it could also have legal origins, as large businesses increasingly engage in defensive patenting to protect their technological lead by creating a dense, overlapping thicket of patents. Consistent with this hypothesis, Ufuk Akcigit and Sina Ates (2023) document a substantial rise in the concentration of patenting among superstar firms and estimate that changes in technological adoption can explain why dynamism has declined, why incumbent enterprises enjoy noncompetitive rents, and why productivity growth has fallen.
A dynamic in which the advances in productivity are being captured by industry leaders, rather than diffusing across the economy, has been noted on this blog a number of times in the past (for example, here and here). Technology diffusion is hard (as an historical example, here is an earlier post on the diffusion of the fork as a dining utensil). The report just released by the European Commission, written by Mario Draghi, about “The future of European competitiveness,” emphasizes the how productivity growth has lagged for small- and medium-sized firms in Europe. There are other potential culprits for the productivity slowdown. A related idea is that economies may have become slower in reallocating resources away from slower-productivity firms and sectors toward higher-productivity areas (see here and here). As Peters also notes, a variety of growth models suggest that lower population growth may also reduce economic dynamism and productivity growth. A recent study from the McKinsey Global Institute argues that the lower levels of productivity can be largely traced to lower levels of investment in tangible capital.Are there any encouraging signs? In the same September 2024 issue of F&D, Nicholas Bloom argues that “Working from Home is Powering Productivity.” He lists various reasons why productivity can be higher for those who work at home at least a couple of days each week: 1) avoiding a commute to-and-from work means that the day’s work happens in less time; 2) employment of those with a disability is up sharply since the pandemic, especially in work-from-home occupations; 3) employment by prime-age females is also up since the pandemic, perhaps in part because occasional work-from-home makes it easier for a family to deal with child-care responsibilities; 4) work-from-home involves more intensive use of residential space–now being used partly as work-space, but less intensive use of commercial office space, which can then be reallocated to other uses; 5) traffic is moving a little faster with the rise in work-from-home, and even a few minutes faster on average adds up to substantial time savings when summed across all commuters, and reduces pollution as well; and 6) there is a positive feedback loop from more people working from home and innovations in the software tools and business practices that can reduce costs and increase benefits from work-from-home.I don’t expect work-from-home to solve the productivity woes for the US and Europe. Indeed, a number of the gains that Bloom cites, like reduced commuting, are both very real and not captured very well in economic statistics about output and hours worked. But there is at least some preliminary evidence that the economic dislocations of the pandemic have also led to an upsurge in new US firms, at least some of which are surely taking advantage of work-from-home and information technology gains.More By This Author:Everything You Want To Know About Inequality: The IFS Deaton Review Going Cashless: Benefits And Costs The U.S. Decouples From China, While The EU Tightens Ties
