Thursday, May 03, 2007

Investment and Productivity

This morning the BLS released new data on productivity growth in the first quarter of 2007. The numbers were somewhat better than expected, as Marketwatch reports:
WASHINGTON (MarketWatch) -- The productivity of the American workplace remained healthy in the first quarter, while wage costs were tame, the Labor Department estimated Thursday.

Productivity of the U.S. non-farm business sector rose at a 1.7% annual rate in the first quarter. Unit labor costs -- a key gauge of wage-push inflationary pressures -- rose 0.6% annualized, well short of expectations.

The stronger productivity and weaker labor costs that expected left economists puzzled. The quarterly productivity number was much better that the 0.8% gain expected. And economists had expected unit labor costs to jump 2.1%.
To be perfectly honest, however, quarterly productivity numbers don't do much for me. They're very volatile, and productivity is mostly important because it is the driver of long-run improvements in living standards. So I far prefer to take a much longer view at productivity than what happens in any one quarter.

Unfortunately, when you look at the trend, productivity growth has clearly slowed in the US in recent years. Over the past 2 years productivity growth has averaged about 1.7% per year. By contrast, during the first five years of the decade, productivity grew at an average annual rate of about 3%.

Could this have anything to do with the surprisingly weak business investment in new equipment and software that we've seen in recent years? The issue of weak investment was highlighted recently by Paul Krugman; for a thorough discussion of the problem see Menzie Chinn.

Take a look at the following picture. The blue line shows annualized productivity growth in the US, measured over 24 months to smooth out quarterly volatility. The red line shows the level of investment in equipment and software as a percent of GDP three years earlier. So for example, the right-hand end-points of the series indicate that productivity grew by about 1.7% over the period 2005:Q1 - 2007:Q1, and that E&S investment was about 7.3% of GDP during the four quarters leading up to 2004:Q1.

The obvious correlation between the two series is driven primarily by the large boost in investment during the period 1995-2001, and the subsequent boost in productivity growth from 1998-2004. But other periods seem to show substantial correlation as well.

What might this imply about the future? As the last picture shows, we already know what investment spending was during the period 2004-06. This may suggest something about productivity growth over the next couple of years.

If the correlation between investment spending and productivity remains consistent with experience, perhaps it would be wise to start getting used to relatively modest productivity growth numbers like the ones we received today.


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