After a slump in 2016, the world economy is picking up. A June 7 report by the Organisation for Economic Cooperation and Development (OECD), a club of rich countries, forecast that the world economy will grow 3.6 percent next year, the best global growth since 2011. In April, the International Monetary Fund predicted that the average unemployment rate across the world’s advanced economies will drop to 5.8 percent in 2018, the lowest rate in a decade. Business optimism is high, and stock indexes are near record levels.
But hold the champagne. A May 18 report by the OECD offers a far more sobering perspective. The advanced economies, the report says, are experiencing “slowing rates of productivity growth.” Other data indicate that the same trend is underway in many less affluent nations. This means that the outlook across most of the world is sluggish economic growth that will raise wages and improve living standards only slowly over the longer term—and will leave festering discontent among the many who are falling behind in a slow-growing world economy.
There is no inconsistency between this short-term optimism and long-term caution. In the short term, a business cycle rebound, large government deficits in many countries, very low interest rates, and healthier banks have combined to boost economic growth and raise incomes. Governments have considerable control over this process. In the longer term, however, the rate at which living standards improve depends almost entirely on the productivity growth rate. And when it comes to raising productivity growth, governments everywhere have poor records. Government spending, tax policy, and monetary policy—the tools in economists’ standard toolkit—cannot do much to solve this problem.
THE PRODUCTIVITY CYCLE
Productivity is a measure of the economic output produced from a given quantity of labor, capital, and other inputs. The best-known variant is labor productivity, usually defined as the output from an average hour of work, but economists also attempt to evaluate whether capital and new technology are being put to more productive use over time. When productivity growth is rapid, so is the increase in the amount of wealth an economy produces.
Ever since the Industrial Revolution, productivity growth has tended to move in long cycles. In the United States, by most estimates, it was fairly slow in the Civil War era, faster in the late nineteenth century, sluggish from around 1900 into the early 1920s, and more rapid over the half-century ending in 1973. The period between 1948 and 1973 was notable because the strong growth in U.S. productivity was matched or exceeded across Western Europe and Japan. As a result, those postwar years were arguably the most remarkable period of economic growth in human history, with the world economy expanding at an annual rate of almost five percent. With the economies of their countries growing so fast that some quadrupled in size in the span of 25 years, hundreds of millions of people experienced unimagined improvements in their living standards year after year. This era, not without reason, is often referred to as the golden age of productivity.
Since 1973, the story has been rather different. Weak productivity growth across much of the world, coupled with a long-term decline in the share of national income paid out in wages, has meant slow improvement in living standards for most people and declines in living standards for some. This has had important political consequences. Widespread support for the welfare state in the 1950s and 1960s was based on the belief that steady economic growth and rising incomes were the work of wise, well-meaning governments. As incomes and business profits rose, so did tax revenues, making it painless to fund health care programs, pensions, and other social benefits. But governments’ inability to restore rapid economic growth and full employment after 1973 led voters to doubt their ability to sustain better living standards as stagnating wages made the rising cost of the welfare state more burdensome. This failure smoothed the way for conservative politicians, such as Margaret Thatcher and Ronald Reagan, to tout market-oriented policies as a way of spurring productivity, but it also created openings for populists espousing anti-establishment, anti-immigrant ideologies. The progenitors of many of today’s populist parties, railing against mainstream parties, trade agreements, the European Union, and globalization, got their starts amid the economic disappointments of the 1970s. Those disappointments have persisted, as governments employing widely divergent policies have been unable to end the productivity slump and deliver the higher living standards their citizens expect.
Governments employing widely divergent policies have been unable to end the productivity slump and deliver the higher living standards their citizens expect.
WHAT GOVERNMENTS CAN'T DO
To see how serious this problem has been, consider the best-known measure of productivity: labor productivity, roughly defined as the amount a worker produces in an hour of work. Labor productivity growth has been in long-term decline in almost every wealthy economy. In Belgium, it increased by nearly seven percent per year in the early 1970s but has averaged only one half of one percent over the past decade. Finland, the erstwhile high-tech superstar, has seen its labor productivity growth rate slip from five percent a year in the early 1970s to near zero today. France, Germany, Japan, and the United Kingdom have all seen labor productivity growth sag even more than the United States. Even South Korea, which has expanded faster than any other wealthy economy in recent decades, now has a labor productivity growth rate of roughly three percent per year—far below the six percent it enjoyed in the 1970s. The slump has spread well beyond the wealthy economies. The Conference Board, a business organization, reckons that labor productivity in Russia has actually been declining. Comparable data for China are not available, but the Conference Board estimates that China’s output per worker rose between three and four percent in 2015 and again in 2016—a far cry from the double-digit rates recorded a decade earlier and a sign of a festering productivity problem.
A global perspective is important here. In the political arena, slow productivity growth is inevitably tied to particular policies that are under attack: high tax rates; the supposedly tight monetary policy of the European Central Bank; tougher U.S. banking rules following the financial crisis that began in 2008; and the overweening bureaucrats of Brussels, Tokyo, and Washington. But the fact that slow productivity growth is a global phenomenon suggests that any one country’s laws and regulations have little to do with the problem. It also suggests that governments have far less power to fix the productivity slump than the public believes.
Governments are by no means bystanders when it comes to improving productivity growth. Indeed, the rapid gains of the golden age were due in good part to state initiative. Thanks to large investments in education, university enrollments in France and Germany tripled between 1950 and 1965, and the average schooling of working-age Americans went from 8.5 years in 1950 to nearly 12 a quarter-century later, creating a labor force capable of handling far more complicated work. Government-financed construction of the U.S. Interstate Highway system and its counterparts in Japan and Europe gave productivity a strong boost by enabling truckers to move freight longer distances more quickly and by allowing employers to recruit from wider labor markets. Publicly funded agricultural research led to far higher crop yields per acre. International trade agreements were crucial as well: the 1957 Treaty of Rome, which created the European Economic Community; the 1965 U.S.-Canada auto pact; and successive rounds of the General Agreement on Tariffs and Trade all lowered tariffs and other trade barriers, putting pressure on manufacturers to be more efficient and innovative in the face of greater foreign competition.
FASTER GROWTH ON THE HORIZON?
Unfortunately, those high-impact measures to boost productivity cannot be repeated: the effects of improving a freeway with a new entrance ramp are insignificant compared to the gains from replacing a traffic-clogged, two-lane road with a limited-access highway, and previous trade agreements have brought tariffs to such low levels that the effects of new agreements will be marginal in comparison. Further gains in productivity must come largely from new products and new business methods. Here, the historical record suggests that periods of rapid productivity growth arrive unannounced and depart unpredictably. Often, it takes many years before a technological advance or an innovative idea has a meaningful economic impact. Many countries, for example, enjoyed a spurt of productivity growth in the late 1990s as businesses reorganized their operations around the Internet—three or four decades after the developments in computing and communications that made the Internet possible. That productivity spurt, which briefly brought better wage gains for many workers, was anticipated by no one, and it ended as abruptly as it began.
The advanced economies have experienced more than four decades of sluggish productivity growth. Governments, it is clear by now, can do very little to influence this situation, at least in any predicable way. Improving infrastructure, supporting scientific research, and fostering education and worker training all may contribute to faster productivity growth over time, but no one can say how quickly those investments will pay off—or whether they will pay off at all.
If productivity is to soar again, it will almost certainly be the result of innovations taking root in the private sector. This is not unimaginable: developments such as artificial intelligence, virtual reality, and nanotechnology don’t seem to have done much for productivity growth so far, but it’s entirely imaginable that they will revolutionize business tomorrow. If they do, and if the resulting income growth is shared widely among workers, it would be wonderful indeed. But unless that happens, the world is likely to be stuck with an economy that is pretty ordinary.