Productivity: What Is It, and Why Do We Care About It?: Disaggregation by Source and Sector Yields Important Insights

Business Economics, Oct, 2001 by Charles Steindel, Kevin J. Stiroh

Economists, business analysts, and policymakers have all focused considerable attention on U.S. productivity growth in recent years. This paper presents a broad overview of productivity--both labor and total factor--and discusses why it is such an important topic. We begin with the official U.S. productivity statistics prepared by the U.S. Bureau of Labor Statistics and discuss several stylized facts. We show how productivity relates to critically important variables like long-run growth, living standards, and inflation. We then describe the proximate factors that determine labor productivity using a standard growth accounting framework. Finally, we outline a series of unresolved productivity issues that have direct implications for the future of the U.S. economy.

Recent years have seen widespread discussion of productivity, and for good reason. It appears that U.S. labor productivity growth has improved sharply, perhaps approaching the pace of the "golden age" of the 1950s and 1960s. To put the importance of this recent change in perspective, consider the direct impact. If labor productivity were to grow at 1.4 percent per year (the average rate from 1973 to 1995), output per hour would rise by 33 percent after twenty years. Growth of 2.4 percent (the average for 1995-2000) implies that it would be 64 percent higher after twenty years. Clearly, the rate of productivity growth can have an enormous effect on real output and living standards. (1)

The debate about the sources and sustainability of the recent productivity revival has often hinged on somewhat obscure concepts such as "cyclical" and "trend" components of productivity; differences between "labor" and "total factor" productivity; and the relative importance of factors like "capital deepening," "spillovers," "productivity of computer output," and "productivity of computer use." Many of these terms are not only similar in wording, but the intellectual differences between them can also be quite subtle.

This paper aims to elucidate the key ideas and concepts in the economic analysis of productivity and apply them to recent trends. We begin by describing the most commonly used measures of productivity, discuss the importance of productivity for several major economic variables, sketch some of the factors believed to determine productivity, and finally note several open research questions in this area.

What is Productivity?

This section discusses the measures of productivity that are most widely used by economists and business analysts and reviews their most noteworthy empirical characteristics. We start with the most basic concept of labor productivity-defined simply as real output per hour of work. We then deal with the more difficult concept of total factor productivity--defined as real output per unit of all inputs. This reflects, in part, the overall efficiency with which inputs are transformed into outputs and is often associated with technology, but it more accurately reflects the impact of a host of other factors like efficiency gains, economies of scale, any unaccounted inputs, resource reallocations, and others. Finally, we review some limitations of these measures.

Labor Productivity

Perhaps the most noted measure of productivity is the Bureau of Labor Statistics' (BLS) series on output per worker-hour for the private non-farm business economy, an index of labor productivity (BLS, 2001b). Similar measures have been calculated since the 1800s, when Congress expressed concern that human labor was being replaced by industrialized machinery--not so different from the concerns of some workers today!

We first examine the evolution of labor productivity in the post-war period. The four-quarter change in private non-farm labor productivity is plotted in Figure 1. (2) Two features stand out. First, labor productivity growth has an obvious cyclical component: low or negative during recessions and high in the early stages of expansions. This procyclicality of productivity is well known and largely reflects the lack of instantaneous adjustment in factor markets. (3)

Second, looking beyond the cyclical movements, labor productivity growth was decidedly lower in the twenty years or so starting in the early 1970s than in the earlier period. Despite considerable research, this "productivity slowdown" remains largely unexplained. (4) From 1996 onwards, however, there has been a sharp strengthening in productivity growth to rates similar to the earlier period. From 1959 to 1973, non-farm business productivity grew 2.7 percent per year, then dropped off to 1.4 percent per year for 1973 to 1995. From 1995 to mid-2001, however, productivity growth averaged 2.4 percent per year. (5)

The non-farm business series is only one of many measures of labor productivity produced quarterly by BLS. BLS also regularly produces measures of output-per-worker hour for all private business (adding back the farms), for non-financial corporations, for manufacturing as a whole, and for the durable and non-durable components of manufacturing separately. These series are published quarterly (BLS (2001b)), and are available at http://www.bls.gov/lprhome.htm.>