Turning around the productivity slowdown 

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Productivity is the amount of output for a given unit of input. At the level of a country’s economy, it is GDP divided by hours worked. Early on in the pandemic, quick and significant layoffs and the rapid shutdown of some lower-productivity sectors caused productivity to spike. As businesses started to reopen and the stimulus was flowing through the economy, demand returned rapidly while employment grew more slowly. Productivity climbed, raising hopes that this effect might have staying power. But this proved to be a fleeting burst. The past two quarters have produced dismal productivity numbers—in fact, the largest two-quarter declines since the 1940s.

Productivity can fluctuate and is quite hard to accurately measure, so it’s too soon to know for sure if alarm bells should be going off. Certainly, businesses are facing multiple disruptions that have created inefficiencies and higher costs: inflation, particularly in energy prices; rising interest rates that discourage investment; labor shortages; and supply chain bottlenecks that encouraged companies to stockpile inventories. As workers are rehired, this could decrease productivity for a number of reasons. One driver could be that staffing levels were temporarily unsustainable before – workers were burning out and companies needed to have more people to do the same work. As hiring increases in lower average productivity sectors, average productivity will also fall. And as new employees are hired, there is a lag due to the time that is required to get new employees up to full proficiency and productivity. All of these things affect productivity and could be temporary headwinds or the makings of a deeper downturn, and only time will tell.

The lack of productivity growth in the US economy is a longer-term trend that pre-dates the pandemic. The widespread adoption of information technology fueled a productivity surge in the late 1990s and early 2000s, but since then, US productivity growth has been anemic at best.

Why does all this matter? Robust productivity performance remains one of the fundamental components of a healthy economy and broad-based prosperity. It is the fuel that makes it possible for a country’s economy to grow faster than its workforce, thereby increasing per capita GDP growth. Higher output, after all, makes it easier for employers to raise wages—and while the link between productivity and wage growth may have weakened in recent decades, it still exists. If companies pass on the savings to customers in the form of lower prices, households and businesses are left with more money to spend elsewhere. Companies can also reinvest productivity into better quality products at similar prices, or reinvest savings from more efficient operations into new activities that create additional growth and jobs. When productivity growth stalls, these types of virtuous cycles can grind to a halt along with it.

There is some cause for cautious optimism, though. Businesses have been investing heavily in automation and other cutting-edge technologies. We are not yet seeing the impact in productivity statistics, but there is typically a lag between the initial adoption of a new technology and capturing the full benefits. Similarly, the United States has made a major commitment to invest in its aging infrastructure nationally. Major projects will take time to complete, but when they come online, U.S. businesses will benefit from improved transportation, power, and communications networks. Additionally, the productivity performance of businesses and sectors does not slow down or speed up in unison—and the manufacturing sector stands out as a bright spot amid 2022’s disappointing productivity numbers for the economy as a whole.

To turn things around, it makes sense to focus on the growing gap between the most productive, profitable firms and the longer tail of lagging and smaller firms. The McKinsey Global Institute has estimated that more than three-quarters of the productivity growth required needed to reignite the economy could potentially be achieved through “catch-up” improvements—that is, closing the gap between lagging companies and those on the productivity frontier. Immigration that drives greater inflows of talent, particularly for higher-productivity jobs and higher-skilled work, can also help increase productivity in a low unemployment economy.

A lot can be done to create momentum. Large corporations may be able to catalyze change by spreading innovations and new technologies across their entire supply chains and ecosystems. Companies will also play a critical role in retraining workers for higher-skilled jobs, particularly working with new technologies.

To incent broad-based change, companies need competitive pressure to improve performance as well as a business environment and institutions that enable innovation and creative destruction. Policy can support these efforts through procurement strategies, R&D incentives for the private sector, and better and faster cycles of research. Competition rules and the regulations governing products, business formation, construction, and labor markets may need a fresh look to remove barriers to business dynamism. In other words, go looking for red tape and cut it.

Reversing the recent productivity slowdown is an urgent priority. Productivity is much more than the technical measurement of how much output is created relative to a given level of inputs. It is a marker of the nation’s innovation, efficiency, and competitive edge in global markets. It is the fuel that makes the economic engine hum and one of the keys to sustaining growth in living standards. It comes from continuously improving the performance, quality, or value of products—in short, from building a better mousetrap. The United States, with its open economy, flexible labor market, and strong legacy of innovation, should be able to crack the productivity puzzle.

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