Not only has America’s productivity wonder survived its first recession; it has positively thrived. Output per man-hour in the non-farm business sector rose at an annual rate of 8.6% in the first quarter of this year, its fastest growth in 19 years. Quarterly figures are volatile, yet the year-on-year growth in productivity was also impressive, at 4.2%. This bodes well for America’s future economic growth—but not necessarily for company profits, or for share prices.
Commentators cheered the latest evidence of rapid productivity gains, hoping that it might promise fatter profits ahead. That America’s productivity continued to rise last year, in contrast to previous recessions, seems to confirm that an increase has taken place in trend productivity growth. Still, the latest numbers overstate the underlying trend.
First, the growth in output, and hence productivity, was inflated in the first quarter by a big swing in inventories. Productivity often surges in the first year of a recovery after recession, as firms produce more without needing to hire extra workers. Productivity rose by 4-5% in the first year following both the 1981-82 and the 1990-91 recessions. Firms have actually continued to cut jobs this year, lifting the unemployment rate in April to an eight-year high of 6%. Today’s best guess is that trend productivity growth is around 2-2.5%. That is less than the 3-4% claimed at the height of the new-economy bubble; but still well above the 1.4% average over the two decades to 1995.
A second, more fundamental quibble is that, although profits will certainly rebound this year, as firms continue to trim their costs and revenues rise, in the longer term faster productivity growth does not automatically mean faster profits growth. A new study by Stephen King, chief economist at the HSBC bank, concludes that workers and consumers have received the lion’s share of the productivity gains of the revolution in information technology (IT). Companies have received relatively little reward for their risk-taking.
In the late 1990s it was widely assumed that faster productivity growth would mean higher profits (so justifying higher share prices). Over the previous half-century a strong positive relationship had indeed held between productivity and profits. In the 1990s that relationship broke down. Despite a surge in productivity, national-accounts profits (as opposed to profits reported by companies, a less accurate measure) fell between 1997 and 2000, even before the economy dipped into recession. At the end of 2000 the profits of America’s non-financial firms were no higher in real terms than in 1994, implying a big fall in their share of GDP.
Mr King argues that workers (who are, naturally, also consumers) were virtually the sole beneficiaries of the new economy, in the shape of faster real wage growth. This was partly thanks to a fall in the prices of IT goods that they bought. More important, the same IT that spurred productivity also increased competition more widely across industries, from airlines and banking to insurance and cars, squeezing prices and profits. Information technology reduces barriers to entry, and makes it easier for consumers to compare prices.