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Innovation and Productivity Go Hand in Hand

Article by Ike Brannon January 30, 2014 //   7 minute read

The end of Christmas has always struck me as a melancholy time.  Fortunately, my spirit is always buoyed by two of my favorite events which occur shortly thereafter: (1) the Pekin (Illinois) Insurance Holiday Basketball Tournament; and (2) the American Economic Association’s (AEA) annual meetings. 

Each event involves a heavy dose of my favorite things. The Pekin tournament features eight high school basketball games, from 9 a.m. to midnight, for three straight days, while the AEA meetings host hundreds of economic sessions over a three day span.  Crowds will gather when a top college prospect is on the court or a former Fed chair deigns to speak, but most of the time, I sit amongst empty seats.

Which is a pity, because last month I saw some great basketball and heard a few scintillating hours of economic debate in a session entitled “Has Innovation Stopped Driving Growth?” I’ll save the basketball vignettes for my sports blog, but the economic session is worth highlighting here.

Perhaps the central question in economics today is what can be done to ensure more long-run growth. During the aftermath of the Great Recession, the debate has receded while policymakers and voters focused on short-term measures to boost economic and employment growth, most of which involve stimulating demand in some way.

But those types of policies can’t help boost the long-run productive capacity of the economy, which ultimately requires that we come up with ways to boost how much workers produce for each hour they work. This is what economists mean when they talk about productivity.

There are three different things we can do to increase productivity: (1) increase the amount of capital workers have at their disposal (such as factories, tools, robots, and the like); (2) give workers more training and education; or (3) figure out better ways to combine labor and capital, something we call total-factor productivity, or TFP.

Robert Gordon, one of the most prominent scholars on economic growth in the country, despairs of the economy returning to stronger long-term economic growth. He began the session by reminding us that everything that brings more growth, besides TFP, has a natural brake: we can't indefinitely add more hours or more workers, especially if labor market growth continues to slow. And at some point adding capital to an existing stock of labor becomes minimally productive—like stacking ox-carts on ox-carts, as an old saying goes. Improving the educational proficiency of our nation’s workers so that they’re more productive is an undertaking we’ve been trying to do for decades, and if we were to succeed tomorrow it would require more decades before we were to see a measurable impact in the labor market.

But then Gordon tried to explain why he thinks TFP will be lower the next few years and was utterly unconvincing. I grant that we had unnaturally higher measured productivity growth the last couple of decades—the 1990s, when annual productivity growth exceeded 2.5%, was no doubt anomalous to some degree, and we may have overstated the gains in the 2000s because of measurement issues, a brief that Progressive Policy Institute economist Michael Mandel has convincingly prosecuted.

Based on this downward trend in total-factor-productivity Gordon concludes that we are doomed to have small productivity gains in the foreseeable future. But I don't see strong evidence that we can predict productivity changes from year to year, except insofar as the business cycle impacts it. Productivity isn’t correlated with investment or any other macroeconomic statistic, and it shows only a weak correlation to the previous year’s number. It really does depend on a large degree to good ideas and—crucially, ITIF economist Rob Atkinson argues—their dissemination across the economy.

Gordon also downplayed the latest innovation thought to be a potential game changer, namely the advent of “big data”, as presaging future productivity gains, which he said thus far has been used solely to improve marketing to yuppies. If that's what he really thinks (maybe he was just trying to get a rise out of those of us paying attention) then I think he's out to lunch. Things like Airbnb and Uber promise to dramatically increase the capacity and productivity of our current consumer goods, and I think we've just scratched the surface there.

A former colleague of mine, University of Dayton professor Mike Gorman, worked in logistics for a railroad after graduation.  His main project entailed figuring out how to take trains arriving in LA from Chicago and arranging them so they returned to the Midwest filled with stuff at a good price while spending the least amount of time idle in California. Given that there are multiple West Coast ports and an infinite number of combinations of rail cars and places along the way to pick up goods, it was an enormously complex problem. Each year they managed to get about seven to ten percent better, thanks to better computing power, new theoretical constructs, and more experience on their part. That pace hasn’t receded, and with more data and computing power, there’s no reason to think it will anytime soon.

Why can't big data do something similar for Uber?  If car sharing could someday reduce the number of cars people own by, say, ten percent, it would mean we could produce a couple million fewer cars each year and use those resources to do something else consumers want. That is, in essence, the flip side of productivity: one produces more goods and services with the same number of workers and the other gets us to the same level of consumption with fewer consumer goods.

Long-run economic growth has a lot of headwinds: an ever-encroaching regulatory state, massive unfunded entitlement liabilities that will likely mean higher future taxes, financial markets that have yet to recover from the Great Recession, and a greying labor force that has been growing very slowly.  But as long as investors and entrepreneurs are still betting on new and innovative ways to produce and do business, productivity growth—and our standard of living—will increase, in fits and starts.