Will productivity improve? Not over the long term

Low Productivity Growth: The Capital Formation Link

Here is a great read on productivity out of the Fed Reserve Bank of New York. Much research has been committed to understanding why productivity has been weak since the financial crisis.


I will not go into all of the theories as to why productivity has been weak here, but the three primary factors are related to productivity gains are the skill set of the workforce, the growth of basic technological and management knowledge, and the growth of capital per worker.

Typically we measure the skill set of the workforce by their education levels. This has certainly not been additive to productivity as educated individuals are replacing others with equal or greater education. So, while there might be an actual increase in skills (the new worker might be more knowledgeable running software that automates tasks – VBA as an example), this would be impossible to measure without conducting a survey that asks every worker about their experiences with different software.

More importantly, going forward, the technology knowledge gap will shrink as more employees enter the workforce whom were raised on computers. And since these next generations will have the same bachelors degrees, it should be expected that this part of productivity will not grow.

The second factor, technological and managerial knowledge has a more interesting future. For instance, it is common to believe that more AI and automation will increase productivity as the output will remain the same but the number of workers required for that output will decrease. Thus, productivity will increase. While this makes intuitive sense, there is one major flaw: the displaced workers will work somewhere. Unless, of course, the government is willing and able to care for the displaced workers indefinitely. There could be educational programs designed for displaced workers, but this does not solve the problem as younger, even more educated (i.e. skilled) workers will continue flooding the market. The displaced workers will simply look for other low skill jobs to replace the one they lost. This will offset the increased productivity from automation as the number of workers and output remain the same.

All of that said, if you change one of the variables in that string, you can have a very different world. I tend to believe the situation I described is most near reality; assuming the government does not decide to pay for the living costs of it’s citizens indefinitely.

The final factor – capital formation – is equally interesting to discuss. More specifically, capital formation is the amount of business investment focused on improving the efficiency of the workers. As the article outlines, empirically, the growth of capital stock and private investment after depreciation have been weak.

capital stock

I do have a few theories as to why this measure is weak. First off, over the long term, the amount of increased efficiency workers get from technology is marginal. Let’s call this the Law of Diminishing Technology (well, perhaps a better name is needed in the future as the Law of Diminishing Technology seems to infer that technology is becoming useless over time…). I define the Law of Diminishing Technology as over time the amount of efficiency/productivity gained from technological improvement for the workforce diminishes because the latest tools/technology are incremental at best and do not improve efficiencies/productivity by a meaningful amount. Sure, if one jumps from 1980s software to 2017 software overnight then there will be a significant increase in efficiency and productivity (on second thought, that business might grind to a halt if none of the employees have used a non-1980s system). More seriously, just about every business upgrades and adds new technology incrementally. Thus, particularly in the last 3-5 years, the efficiencies and productivity gained on the latest technology is not meaningful.

As you can see, the future trend for productivity is not bright. We are likely to see a prolonged period of lower productivity than we have seen in the past. But that has less to do with the workforce and more to do with the natural market. This discussion ultimately comes down to the fact that over the very long term, we should not expect the same gains as the past. It is not sustainable to invent new education for the sake of making people appear to have more skills. We cannot expect the efficiencies that technology has provided over the last 40 years to remain the same over the next 40 years. These will flow through into economic activity and productivity.

Categories: Productivity

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