Arnold Kling  

Story of the Year

Economic News for the New Year... Even Bigger Than Arnold Thinks...

I have an essay on what I call the Most Important Economic Story of the Year.

The average productivity growth rate in the last five years is the highest over the past half century.

For Discussion. What do you think is the most important economic story of the year?

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CATEGORIES: Growth: Consequences

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The author at Freedom Democrats in a related article titled A productivity story? writes:
    Arnold Kling's most important economic story of the year: The average productivity growth rate in the last five years is the highest over the past half century. This is really important, as increasing productivity is the driver for long term economic grow [Tracked on December 29, 2005 11:13 AM]
The author at - The War to Mobilize Democracy in a related article titled Japan Emerges from Stagflation… Finally writes:
    The good economic numbers keep coming out of Japan, but perhaps the best news is that the House of the Rising Sun is starting to experience a little price inflation. No, that is not a typo — I said inflation. Gross domestic product (GDP) increa... [Tracked on December 30, 2005 12:46 PM]
COMMENTS (20 to date)
Victor writes:

I still doubt that the 2%-point productivity growth suggested by Fogel is sufficient to get Social Security to solvency. At least not without some help from other assumptions. Some illustrative calculations by Andrew Samwick of Voxbaby can be found here; something closer to 3% would likely be required.

But to your broader point, I agree that the productivity story is not only one of the biggest of this decade. It is also under-reported and under-appreciated. I presume this is because the benefit of that productivity doesn't appear to be evident in real wages, or in stock growth. Sooner or later, if productivity growth continues this will turn around.

Raul writes:

Excellent Post!!!

Arnold, you have a tremendous ability to get the essence of a problem.

Many economists get lost in the details and forget that main effects carry most systems forward.

Productivity is a great measure because it characterizes the input/output structure of the nations production function .

eric writes:

How about my favorite published econ paper of 2005? I nominate Fact-Free Learning in December's AER. Cast off the chains of the bayesian "another ball from the urn" paradigm for modelling information.

Stefan Karlsson writes:

Arnold , you are simply dead wrong in assuming that the allegedly higher productivity growth will somehow save America from the rising costs of Medicare.

First of all, the productivity numbers which you like som much is highly misleading for several reasons. First of all they fail to take into account the deteriorating terms of trade of the U.S. private sector relative the rest of the world and government. Secondly, the numbers for recent years require a highly implausible reduction in hours worked which incidentally is contradicted by other government data which show a small but still positive increase in hours worked. GDP growth for the 2000Q1 to 2005Q1 period was only 2.6% per year, which means that for productivity growth to be 3.4%, hours worked must have fallen 4% during that 5-year period.

Moreover, even if it were really true that hours worked have fallen, it wouldn't do the economy any good as the important thing for the tax base is production, not productivity.

Furthermore, as a higher productivity growth would mean that pay for doctors, nurses etc. would be bid up, this wouldn't mean any reduction in the relative burden of medicare. To illustrate this fact, just consider tha during that period of allegedly high productivity growth, the cost of medicaid and medicare rose from 3.4% of GDP in fiscal 2000 to 4.2% of GDP in fiscal 2005.

Fritz writes:

This higher trend in productivity is the result of lassir fair Reagan economic policy along with low marginal tax rates. The creative destruction being allowed in the economy (Clinton himself accepted continued downsizing as good policy) combined with higher computer processor speeds will allow for higher growth rates absent inflation. The only thing holding back even greater productivity improvement, is the failure of the public delivery system of K-12 education. Substantially increase the pool of qualified 12 graders for higher education, potential GDP would be even higher.

Steve Sailer writes:

I'm dubious about the validity of productivity numbers since the denominator, the number of workers, is only vaguely known due to the enormous influx of illegal aliens.

Here in Southern California, with its huge suppoly of illegal immigrants, I see lots of evidence of an abundance of labor being used in wasteful ways -- for example, there are no automated car washes, just old fashioned ones with gangs swarming over your car. Or consider the spread of "human directionals," or living signs, people paid to stand on street corners and jiggle arrows pointing to real estate open houses.

Dan writes:


First, you said economic policy means nothing and that the credit should go to Moore's Law. But how does Moore's Law apply to the chart you showed that has an obvious dip in the middle? Moore's Law is a continuous upward trend. Your chart has a dip in the middle. Something must have caused the dip....

If Moore's Law gets credit for our productivity increases, who gets the blame for Europe's miserable showing?

The Big Story of 2005 may indeed be our productivity, but you haven't stated why this nation is so much more productive than, say, North Korea... another Big (but ignored) Story that you posted correctly on.

Matt writes:

Please take a break from the immigrant issue. When labor is less expensive than capital, labor is the efficient way to wash a car.

Net immigration is something like .2% of the population, so it's not going to have a huge effect on productivity.

Matt writes:

I would hesitate to assign the productivity increases to the president who presided over the trough in growth rates. That would be a very tendentious reading of the data, wouldn't it?

James writes:

How important is Moore's law in terms of productivity really? Most big productive firms use computers, sure, but I have to wonder how many actually use those computers for computationally demanding number crunching. In Solow's words, "You can see the computer age everywhere these days, except in the productivity statistics."

What I find more plausible is that across many industries, entrepreneurially alert individuals have found ever more productive ways of coordinating various factors of production, including transistors, but also many other things such as skills, personal relationships, vehicles, machinery, etc.

This is a somewhat unappealing explanation because it doesn't attribute an observed phenomenon to a clearly defined cause. It does, however, account for the fact that other countries with the same access to computers but different institutional arrangements tend to have differing productivity.

nn writes:

I think no "macro" policy accounts for this change.

But good micro policy in the sense of good institutions, limits on regulatory incursion (relative to our major competitors, though not in an absolute sense), security of property rights, high labor mobility, and a generally good climate for the creation and failure of new and innovative enterprises makes possible the productivity gains without "causing" them.

Europe falls down relative to the US on many of these fronts. Moreover, bad policy (high effective minimum wages and pro-union rules) can hinder growth even if the reverse can't be guaranteed to produce it.

Fritz writes:

Not a chance I would agree. The hight of unemployment & inflation trends peaked in the 80's as well and like productivity are all in a positive trend line. Tom Brokaw may think the GM downsizing was the story of 05 as important, but even Clinton recognized, rolling recessions and flexible labor & capital markets is good policy. We are all farmers now, adaptation to changing conditions is mandatory.

Steve Jackson writes:

By far one of the most under-reported stories of the year is Japan's economic recovery.

Chris Bolts writes:

Japan's economic recovery is a great story, but I think the resilience of the U.S. economy despite the fact we are at war and was hit by two devastating hurricanes is even better.

For honorable mention are the riots in France. If that's outright rebuke of France's economic and social policies I don't know what is.

Steve Sailer writes:

I'm fascinated by how economists so self-defeatingly are insistent on paying zero attention to the huge issue of immigration, even though there is tremendous public demand for in-depth empirical analysis. You'll note that George Borjas has taken himself from UC San Diego to an endowed chair at the Kennedy School at Harvard precisely by doing objective analyses of immigration's effects. Where's your self of self-interest? There's a huge demand out there, but we see little supply. That's an intriguing market failure you should study.

Matt writes:


Though I'm not sure what Tom Brokaw has to do with productivity, you have to have a prior belief > .6 that Reagan is God before the evidence would lead you to believe that he is responsible for our productivity growth.

Matt writes:


Borjas has been largely in the "benign to beneficial" camp though, hasn't he?

Lord writes:

Immigration is 0.97% of the population.

I don't think an average over the last five years constitutes a Story of the Year.

David Gitlitz writes:

I have to take issue with the assertion that recent policy choices have been irrelevant to strong productivity performance. Productivity improvements arise out of an environment conducive to capital formation and risk taking intimately connected to the direction of economic policy. In particular, by cutting taxes on investment returns, with the stroke of a pen the Bush administration increased the expected after tax returns to investment, reducing the cost of capital and thereby encouraging a sharp increase in real investment spending. This is the foundation of solid productivity growth and to suggest otherwise is to imply that the economic forces ultimately responsible for a rising standard of living -- which is the real payoff of productivity growth -- are totally random and exogenous, outside the realm of proper policy concern. Centuries of economic history soundly refute that proposition.

spencer writes:

David -- you have a great theory, supported by many. But cuts in individual tax rates do not impact corporate capital spending, and that accounts for the bulk of investment. The population segments subject to individual income taxes only account for some 11% of nonresidential fixed investment and nonprofit institutions account for another 7%. Given that individuals account for so little of capital spending it is hard to see why marginal changes in individual tax rates would have had such a big impact.

If we were still in the world of say, 1850 when corporations played a much smaller role this theory of the impact of individual tax cuts might be important. But we are not in the world of 1850 when this theory would have applied.

If you look at the nature of capital spending over the last quarter century you find that information technology and software account for all of the increase. They increased from essentially nothing to some 6% of real GDP while all other nonresidential fixed investment has remained at around 6% of gdp. This strongly implies that the growth in capital spending was due to technological changes and improved returns to business for using the new technologies and that changes in tax policy for individuals played essentially no role in the
increases in capital spending.

Moreover, this growth in capital per worker and improved use of the new technologies in new and different industries plays a major role in the growth of productivity that Arnold correctly picks as one of if not the single most important
economic story of the year and maybe the decade.

For example, if you look at manufacturing growth over the last quarter century you find that output of IT goods grew at about a 22,6% annual rate while all other manufacturing output only experienced some 1.6% annual growth.

PS. I'm in the school that productivity is cyclical because of labor hoarding rather then "shocks". Because of this productivity growth is one of the best leading indicators of real growth I know.

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