US productivity puzzle: policy priorities

Posted on September 5, 2016

An employee welds together a frame for a sports utility vehicle (SUV) during production at the General Motors Co. (GM) assembly plant in Arlington, Texas, U.S., on Thursday, March 10, 2016©Bloomberg

More skilled labour is one of the improvements that can revive productivity growth

The dramatic slide in US productivity will be one of the defining features of the next president’s economic inheritance. Yet when it comes to diagnosing the causes of the slowdown, or coming up with cures, there is little consensus among economists.

The raw figures are striking. Labour productivity has dropped for three quarters in a row, the longest string of declines since the 1970s. The fall in the second quarter was revised even lower last week, to a 0.6 per cent drop, according to Department of Labor statistics.

    Brendan Duke at the Center for American Progress estimates that the US will produce $2.8tn less in goods and services this year than economists were forecasting just before the crisis, and the lion’s share of the shortfall was because of slower productivity growth.

    Unless productivity growth increases, the US will struggle to lift living standards. What policies would do most to address the productivity puzzle?

    Invest in infrastructure

    Policy overlaps between Hillary Clinton and Donald Trump are rare, but boosting infrastructure investment is one. Both presidential candidates have said they would put extra spending on roads, bridges and waterways high on the agenda. Mrs Clinton has outlined a five-year, $275bn plan, while Mr Trump says he wants to double that number.

    The Congressional Budget Office has found that rises in broader federal investment increase productivity via three channels: spending on physical capital like roads and bridges facilitates commerce; education expenditure boosts skills; and research & development promotes innovation.

    “You get a lot of bang for your buck with infrastructure investment,” said Stephan Danninger, a Washington-based division chief at the International Monetary Fund.

    The cost of inaction in this area is heavy. The American Society of Civil Engineers said this year that gross domestic product would take a $4tn hit between 2016 and 2025 because of lost business sales, rising costs and dented incomes if the country continues to underinvest in its infrastructure.

    Past studies have found construction of the US interstate highway system, that began in the mid-1950s, increased productivity growth as businesses found it cheaper to produce and transport their goods. That was a game-changing project, however: future advances may be more marginal.

    Cut corporate taxes

    Mr Trump has put aggressive corporate tax cuts at the heart of his economic agenda. That chimes with fellow Republicans including House leader Paul Ryan, who have cited flat productivity as a reason for broad tax reductions.

    The justification for taking action on business taxes is the US has the highest statutory rate among advanced economies, which may at the margin be deterring companies from investing here, according to Martin Neil Baily, a former chairman of the Council of Economic Advisers under Bill Clinton who is now at the Brookings think-tank. He advocates lowering the headline rate while broadening the tax base.

    The problem with focusing too much on corporate tax, however, is that America’s rates are in effect lower than the headline rate appears. What is more, countries with extremely low rates — such as Ireland — have also seen ebbing productivity growth, says Mr Duke. “There is no statistically significant relationship between corporate tax cuts and the size of the productivity slowdown,” he wrote in a report last week.

    He argues instead that more needs to be done to stimulate aggregate demand, which will induce companies to spend more, and that wages need to be pushed up to encourage business leaders to invest more and substitute capital for labour.

    Immigration reform

    Mrs Clinton’s economic policies encompass a major overhaul of immigration laws that include a pathway to legalisation for undocumented immigrants — in contrast with Mr Trump’s calls for millions of people to be ejected from the country.

    Bringing more immigrants into the workforce and allowing them to take jobs better aligned to their skills carries a double-benefit, according to Mark Zandi, chief economist at Moody’s Analytics. It lifts potential growth by boosting the labour force, and it enhances productivity because immigrants are more likely to be entrepreneurs and innovators.

    CBO analysis of the so-called Gang of Eight immigration reform bill of 2013, which contained a pathway to citizenship but which foundered in the House of Representatives, found that the legislation would increase the population by about 10m people in 2023.

    Total factor productivity, a measure of innovation, would be boosted by roughly 0.7 per cent in 2023, the report said.

    Boost competition

    A growing body of work suggests there is a problem with US competitiveness. Big companies are capturing a growing share of revenues, and there is a widening gap between the productivity of frontier firms and that of laggards, suggesting Darwinist forces are not operating as effectively as they should. The share of start-up companies in the overall business world has been steadily declining.

    Mr Baily says that the patent system may be one factor that is hindering competitive forces, and he advocates reform to reduce the lives of patents. Another answer may be to beef-up antitrust enforcement, something that the Obama administration has been seeking to do.

    Mr Danninger said: “Compared to a decade or two ago, companies that are medium-sized and productive have a more difficult time to expand. As a result, large firms have become larger and employ a bigger share of the workforce than in the past. The source of the concentration problem is unclear, and the antitrust system may need to adjust to address this problem.”

    Slash regulation

    New entrants into the business realm may also be held back by the US’s labyrinthine and multi-layered regulatory system. Among the changes that some economists urge are a crackdown on the country’s occupational licensing system.

    A quarter of workers require a licence to do their jobs, with the share of workers licensed at a state level up fivefold since the 1950s. This affects professions ranging from manicurists to interior designers, hindering people’s ability to move state and take up new positions.

    Mr Zandi says business may also have been impacted by the introduction of the Affordable Care Act, and the new suite of post-crisis financial regulation. Yet he says companies struggle to define exactly what regulatory barriers are most onerous. “It is hard to point to that as the smoking gun behind the slowdown in productivity growth over the last decade,” he says.

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