U.S. Economy: Has an Era of Increased Productivity Returned?

U.S. Economy: Has an Era of Increased Productivity Returned?

The last time the American economy posted surprising growth figures amid rapid wage increases and moderate inflation, Ace of Base and All-4-One topped the Billboard charts and denim overalls were in style.

Thirty years ago, Federal Reserve officials debated vigorously whether the economy could continue to grow at such a strong rate without causing a rise in inflation. And in 1994, it turned out that this is possible thanks to one key ingredient: productivity.

Now official productivity data shows a significant increase for the first time in years. The data has been volatile since the start of the pandemic, but with the emergence of new technologies such as artificial intelligence and the spread of hybrid work arrangements, some economists are wondering whether the recent gains are real – and whether they can be a lasting boom.

If the answer is yes, it would have a huge impact on the US economy. Higher productivity would mean companies could produce more products per worker. And a steady increase in productivity could enable the economy to recover healthily. More productive companies can pay better wages without having to raise prices or lose profits.

Some of today's trends have parallels to what happened in 1994 – but the differences explain why many economists are not yet ready to declare a tipping point.

By the late 1980s, computers had been around for decades, but had not yet delivered major increases in productivity—what became known as the productivity paradox. Economist Robert Solow said in 1987, “You can see the computer age everywhere except in the productivity statistics.”

That changed in the mid-1990s as semiconductor manufacturing improved and computers became cheaper. Companies began to learn to invest in information technology, resulting in a productivity boom.

For years, economists and analysts have wondered whether we might be experiencing a new productivity paradox: Despite our sudden access to cloud computing, high-speed internet connections and cell phones, productivity gains were muted in the late 2000s and 2010s.

Since 2020, companies have learned how to use existing digital tools in new ways as employees transition to remote work. Will this lead to sustainable increases in efficiency in some industries?

Whether remote work is good or bad for productivity remains hotly debated, as a recent paper by Nicholas Bloom of Stanford University and other researchers explained. Early research suggests that employees may be less efficient when working fully remotely and that hybrid working results in little, if any, productivity gains.

But workers who save on commuting and care time often feel more productive – even if that saved time isn't recorded in official productivity data.

“The studies probably underestimate the effect,” Bloom said, explaining that employees who are happier thanks to workplace flexibility may be less likely to quit — helping companies avoid unproductive retraining. He believes remote work could also allow companies to move “more tedious” jobs overseas, encouraging Americans to work more dynamically.

“The overall story is potentially quite telling,” he said in an interview, predicting that remote work is in the midst of unleashing a decade-long productivity boom. “We are in a brave new world: it will take years.”

In the 1990s, the World Wide Web continued to expand. Companies initially feared that this would distract their workers. (“Oh, what a tangled web this Internet is,” sighed a 1995 New York Times article about online distractions.) But ultimately the tools have streamlined many types of work.

A review of the 1990s boom found that a combination of efficient computer manufacturing and increased use of information technology accounted for about two-thirds of the era's productivity growth.

Today's equivalent of shiny new technology is artificial intelligence. While many economists said it is probably too early to fully realize the benefits of AI, some advocates believe it could prove transformative by automating mental tasks like quoting and emailing.

“There's a lot more to come as more and more people adopt these things,” said Erik Brynjolfsson, an economist at Stanford University, who is optimistic that we could be on the verge of a productivity boost as employees have their everyday skills enhanced by the new tools. He has conducted experiments and found that AI actually helps workers, and is co-founder of a company that coaches companies on how to best use the technology.

But Robert Gordon, a leading productivity economist at Northwestern University, is skeptical. He said that unlike the computer and early internet era, AI may have had its biggest impact on office work – while computer manufacturing also became more efficient in the 1990s, leading to gains in several sectors.

“I don’t think the universality of AI will permeate the economy with such cross-industry impact,” Gordon said.

Another driver of the productivity boom of the 1990s? The companies made major logistical improvements. Walmart grew rapidly over the decade, bringing with it strong supply chain management that allowed it to efficiently stock shelves with affordable products from around the world. Sales also improved, particularly for pharmaceuticals.

One potential challenge is that such gains are difficult to win twice: now that companies have become more efficient, it may be difficult for them to improve dramatically. For example, online shopping continued to revolutionize retail in the 2010s, but productivity gains both within the industry and overall were modest.

This highlights an important point about productivity growth. It's easy to pick simple things like optimizing supply chains using software. Once this happens, it can become more difficult to make profits. The economy eventually reaches higher levels of productivity, but not necessarily sustained high productivity growth.

What can lead to lasting increases in productivity is a boost to innovation that feeds on itself – and that makes the recent uptick in business creation a hopeful sign. New companies are often more inventive.

In 1994, many companies were founded as people sought to capitalize on breakthroughs in information technology. These days, business applications are on the rise again, likely reflecting people's decision to become self-employed after losing or quitting their jobs during the pandemic.

The new surge in business could simply be a result of people switching to working from home, recent research from Fed economist Ryan Decker and John Haltiwanger of the University of Maryland suggests. However, many of the new firms are in potentially productivity-enhancing areas, including online retail, software publishing, computer systems design, and research and development services.

The 1990s and 2020s share another possible productivity boost: declining pricing power.

By the mid-1990s, inflation had already been cooling for years, and Fed officials noted in their meetings that companies were losing their ability to continue raising prices without losing customers. To prevent a decline in profits, companies had to find ways to work more efficiently.

“Necessarily, we will tend to have an increase in productivity because it is imposed on the system,” Alan Greenspan, then Fed Chairman, theorized during a Fed meeting.

Inflation is also falling today. And the job market was strong then, as it is now – meaning companies had to pay a lot to attract workers. When wages rise faster than prices, companies must utilize their workforces more if they hope to maintain profits.

In 1996, Mr. Greenspan was convinced that productivity would rise—and so he convinced his colleagues that they didn't need to try to slow the economy so much. As productivity improved, strong growth was less likely to lead to inflation.

Jerome H. Powell, the current Fed chairman, has praised Mr. Greenspan's “strength” and vision in navigating this period.

It could be a lesson he can draw on in the coming months. Growth remains stronger than Fed officials expected, and policymakers will have to decide whether to respond by keeping interest rates higher for longer.

Currently, Mr. Powell is not convinced that America is in a new productivity boom. “My guess is that we may be back to where we were,” he said during a Jan. 31 news conference.

But he admitted, “I don’t know.”

In the 1990s, it took until 1999 for economists to really believe that productivity had increased, noted John Fernald, an economist at INSEAD Business School. Even if hope is emerging now, confidence could still be years away.