It's productivity, stupid.

Which economy will our grandkids inherit from us: Doomsday, or Easy Street? 

Here's a hint, inspired by a successful political campaign mantra designed to keep the candidate on-message throughout the 1992 campaign:

It's productivity, stupid. 

This article is a follow-up to "The Baby Boom Crunch" I posted last week.  Click on the thumbnail below to watch a movie about the effect productivity will have on our grandkids' economy—in spite of boomer retirements and Medicare cost escalation. 

Here's the productivity movie; click on it to get it rolling:

[To see still shots of each scenario I chose, see the very bottom of the end notes to this article.]

It's impressive what a difference each percentage point makes, isn't it?  Makes me wonder why we never hear anything at all about "productivity" from the Doomsday Squad. 

The Doomsday Squad
Senator Kent Conrad and Comptroller General David Walker, among others, have their opinion as to which way things will turn out for our grandkids: it's Doomsday, no question (...unless we sign up for their remedies, which some call "belt-tightening," but look to me more like a tourniquet around the neck).  But Kent Conrad and David Walker have been hogging way too much of the airtime the so-called free press devotes to our nation's economic prospects; the press reaction to Walker's Fiscal Wake-up Tour is an example.  That kind of one-sided coverage is unfortunate, because there are many experts who disagree with the dogma that says doomsday is inevitable—but they're getting ignored by our free press.   

David Walker said, "We face a demographic tsunami that will never recede." [My reaction: "Never?  Really??"] His list of fiscal challenges is "led by the imminent retirement of the baby boomers, whose promised Medicare and Social Security benefits will swamp the federal budget in coming decades."  Kent Conrad's sound bite, from the same article (in USA Today, Nov'05), was this: "We're not preparing for what we all know is to come. We're all sleepwalking through this period."  [My reaction: "Yes, some of us do indeed seem to be sleepwalking, Senator Conrad."]

The Productivity Squad
If they'd pay some attention to experts who understand what it takes not just to avoid doomsday, but to achieve continued growing prosperity, both Walker and Conrad—if not their gaping groupies—might learn something new and encouraging.  Click on the following thumbnail for specific quotes I selected, from a few of the people who understand the power of productivity: Paul Krugman, Paul Romer, Brad DeLong, Eric Beinhocker, Ray Kurzweil, and William Lewis.  (Even though this group's political leanings are diverse, they have little to no disagreement about the importance of productivity to our economy.) 

And, for the record, here's our track record for the last several years (source: Bureau of Labor Statistics); click to enlarge:

The 64-trillion-dollar question
It's obvious how important our economy's productivity will be to our grandchildren's future, and it's clear what questions we should already be asking our politicians—assuming we'd like to do the right things now to secure that future. 

The formula is pretty simple: In the 64-trillion-dollar question below, just fill in the blank with the policy proposal of your choice.

"Would [Policy X] make the US economy more productive?"

Here are a few specific examples of how easy this is:
• Would an increase in income tax rates make the US economy more productive?
• Would reducing and uncapping the payroll tax make the US economy more productive?
• Would simplifying the tax code make the US economy more productive?
• Would a skills-based immigration policy make the US economy more productive?
• Would deporting all illegal immigrants, if that were possible, make the US economy more productive?
• Would giving illegal immigrants a fine and a structured path to citizenship make the US economy more productive?
• Would an increased flow of legal immigrants make the US economy more productive?
• Would trade barriers make the US economy more productive?
• Would preventing foreign investment make the US economy more productive?

[Interestingly, even national security questions can be framed in this context.  Example: Would the prevention of homeland destruction make the US economy more productive than not preventing it?]

Forming the right questions is easy; try making one of your own for a politician or journalist, using your favorite policy proposal.  Most importantly, let's all start asking them.  The Doomsday Squad is getting off far too easily, and it's time we changed the climate.   

And what better time to start than Memorial Day?  A lot of people have served this country over the years to preserve this land of opportunity for us.  If we miss our opportunities by falling for the doomsday rhetoric without fighting back, I'd say that's shirking our responsibility, wouldn't you?

=============
End note:
The productivity movie at the top was the best way I could think of to depict the results of the fifty-year model built to test various combinations of productivity per worker, retirement costs, inflation, real interest rates, etc., against the demographic projections from the US Census Bureau.  I could have picked the debt-to-GDP ratio as the bottom-line indicator of fiscal well-being, but "interest as a percent of tax receipts" is more to the point; it's a coverage ratio that helps one judge an entity's creditworthiness.  [For reference, interest takes 9% of tax receipts now, compared with 15% ten years ago.]  In any case, as I've said over and over in this blog, a permanent and growing federal debt is not a problem as long as our ability to service the debt grows at least as fast; healthy private sector firms demonstrate this year in and year out. 

For the movie, I chose six outcomes out of an infinite number of possibilities.  But in every case the effect of higher productivity overwhelms just about all the other inputs combined—just as the various experts have been trying to tell us.  The higher the productivity per worker, the better off we'll be.  People like David Walker and Kent Conrad are ignoring productivity at their peril. 

In case you're interested, here's a zoomed-out snapshot of the fifty-year model; click on the thumbnail to enlarge it.  (The graphic was moved on top of the calculations for convenience, but the calculations weren't disturbed.)
 


And here are the six scenarios from the movie, one at a time; click to enlarge.  Questions are welcome:

 

Comments

[Counter Revolutionary]

Previous articles have convinced me on the importance of growth. "GROWTH TRUMPS ALL." (My words) From your post I get an avg productivity gain of 3.11% for the past 10 years. Your movie implies an average of @ 3% gain in productivity reaches equilibrium.

But, and you knew there had to be one, our GDP growth is slowing but not going negative even though the productivity gains for the past 3 years (and probably 4) have been below average. As important as productivity is, it appears it is not the only driver. What is 2, 3 and do they swap positions in importance depending on conditions?

I am convinced on the importance of growth, but I guess still unconvinced on the importance to productivity to growth.

[Perry Willis]

Nice work. Thank you.

I have a productivity question. Would focusing terrorism reduction efforts on interdiction (more Arabic speakers please!), and spending less on overseas military deployments, help productivity?

Here's another, related one. Would we help productivity if we make our response to future terrorist attacks more proportional to the attack (unlike what we did after 9-11)?

Both of these questions are my way of suggesting that questions that use the words "national destruction" aren't serious questions.

[marmico]

The New York Fed has published a recent paper indicating a private output growth rate of between 2.12% and 3.96% and average labor productivity growth of between 1.36% and 3.00%. It also includes some other tables of forecasts.

See: http://www.newyorkfed.org/research/staff_reports/sr277.pdf

It seems to me that these private growth rates would have to be revised downwards to reflect that the public sector accounts for about 35% of the economy.

Productivity growth rates have declined in 2005 and 2006 and the preliminary estimate for 2007Q1 from the BLS is 1.7%.

Now the doomsday problem articulated by the Trustees of the Social Security and Medicare Funds using the intermediate cost assumption of 1.6% productivity growth may still come to pass if future productivity reverts to the 1970-1995 period before the IT boom commenced in the mid-90's.

IMO, Social Security is OK, Medicare (which is a more pressing issue) will need tweaking.

[rufus]

That's a pretty short-term chart. What would it look like if you did it in 10 yr. increments? 20 yr increments? 50 year increments; and, finally, 200 year increments?

Any guesses?

[marmico]

Questions are welcome:

Geez Steve, of the infinite possibilities, productivity growth of 2.0% plus/minus 0.3% is my WAG.

Now if you think that Steve III (your grandchild) will be more productive than Steve II (your son) than Steve I (yourself), then you better bring more data to the table in proof of the assertion.

1. Can you make the movie in 10 basis points increments?, i.e. 1.75% to 2.25%. Not such a big deal, is it?

2. If it is accepted that Social Security and Medicare are the tumbleweeds in the doomsday desert, can you not use their assumptions in your analysis.

http://www.ssa.gov/OACT/TR/TR07/V_economic.html#wp173514

Remember, the BLS surveys the private sector.

3. It is polite and courteous to indicate (tag) that you have updated your original post. Why don't and haven't you?

I know you won't respond. You cherry pick income statements (interest coverage) not balance sheets (debt coverage) as data.

BTW, as you were formerly employed by purveyors of tranfats and glucose-fructose, I sympathize with your hypo (0% productivity)/hyperglycemia (5% productivity) predicament.

Get real!

[rufus]

Who wants to volunteer to go back to 1907 and explain the internet to the folks down at the Church Social? Or, Missile Defense? Or Gene-Splicing? Anyone?

[rufus]

Here's the thing; half of all the Scientists that have ever lived will go to work tomorrow morning. And, they're standing on top of a pretty tall, and rapidly growing, pile of knowledge. Ex:

http://biopact.com/

[Olivier]

I'm skipping this one. Too many colors, too fast. I feel like I'm on 'shroom. Too many undisclosed assumptions. I'm not against productivity and the basic message seems OK to me. Just two things.
1- From the BLS data reported, productivity grows at 3% per annum recently. Yet this corresponds to "not good enough" in the graph --are we doomed then?
2- There is a very simple way to promote productivity: unemployment. Like in all the European countries. I'm not ready to concede that one for the sake of productivity.

[rufus]

I'm guessing that in the 1800's the annual rate of increase in productivity was less than 1/2 of one percent. I'm GUESSING that in the 1700's it was less than 1/10th of one percent. I'm guessing that pre-Biblical times it was less that .01% annually.

I'm GUESSING that someday fifty or a hundred years from now, we might actually see an average annual rate of increase in productivity in the 5% range. Then again, maybe not; who in the heck knows?

[Steve]

CR:
(1) A lot of people, especially politicians, would not think of a 100% ratio of debt to GDP as equilibrium; 36% would be equal to today's ratio, and a lot of them are playing up even that number as some kind of disaster. (2) GDP equals output per worker times the number of workers; that means productivity drives GDP.

Perry:
Destruction prevention is a very serious issue. Do overseas military deployments prevent or reduce destructive terrorist incidents at home? If so, it can be viewed as "defense." If not, it is arguably a waste of resources. And that's mostly what the war debate is all about, isn't it?

marmico:
I'm detecting sarcasm. A word to the wise: that won't get you far here. And the update was only to add the still frames someone requested in an email; nothing else changed except for that addition.

You obviously have a chip on your shoulder, and I strongly suspect it's because your political agenda is getting stepped on somehow; why not explain it to me in a private email? That might help eliminate any grandstanding factor that might be affecting your choice of words.

rufus:
What matters is not the increment chosen, but the comparison with the doomsday scenarios -- and the conclusion is the same. Productivity growth can overcome the SS+Medicare demographics problem.

And one other thing: Why not stop guessing? After reading a few key parts of Ray Kurzweil's book, The Singularity is Near, you should be able to make a few informed hypotheses. It's a lot better than guessing.

Olivier:
Employment and unemployment percentages among the working age population were assumed to remain the same as today in these scenarios. Other assumptions: tax receipts = 18% GDP; real interest rates = 2.7%; inflation = 2.3%; SS+Med cost starts at $11,500 per retiree in '08; additional Medicare premium starts at $1,500 per retiree in '08. Let me know what other assumptions you'd like to see.

And "undisclosed assumptions" is exactly my issue with all the doomsday scenarios in the popular press. Try finding any disclosure of the productivity or GDP growth assumptions behind the doomsday scenarios -- and if you find any, send me the links.

[rufus]

Well, Steve, the question, to me, is whether we can ever reach 5% land as regards Productivity Growth. The point I was trying, obviously not too well, to make was that we've had rather large increases in the % of advancement of Productivity if looked at from a longer time frame.

I'm getting tired and starting to babble; it must be nap-time. G'nite.

[PlainBill]

I retrieved the underlying BLS data for productivity since 1947 (as far back as they have available online), and found the following two interesting things:
1. A simplistic linear interpolation shows that we've been on a slowly dropping long-term productivity trend for 50 years.
2. A moving 4-year average of the yearly data shows only three periods where we have sustained at least a 3% productivity growth: From the beginning of the data up to 1953; 1962-1968; and 2002-2006.

Based on at least this recent history, it appears that sustained productivity gains of more that 2% may be rather hit or miss.

[Steve]

PlainBill:
For a differing perspective, take a look at the first two chapters in the following book:
http://tinyurl.com/yvwr7x

[Bob]

Steve,

Some questions:

Does the BLS have a description of how they calculate productivity at their website?

What is the GDP growth rate in your "good" scenario?

Is it possible to achieve a real GDP growth rate >3% with a 3% productivity growth rate?

What frame breaking developments, in your view, would be required to achieve a 4-5% productivity rate? I'm assuming they do not currently exist.

Thanks.

[Steve]

The BLS has a comprehensive set of stats on productivity, starting here:
http://www.bls.gov/lpc/home.htm

Labor productivity (i.e., per worker) is what most of the people I quoted were referring to, so I stuck with that. A good case can be made for focusing on multifactor productivity, though.

In the "good" scenario (4% productivity growth per worker), nominal GDP growth was 6.39%, of which 2.3% was inflation, 0.5% was working-age population growth; the reason it doesn't quite sum to 6.39 is due to fluctuations in the worker/retiree mix over the time span.

GDP grows faster than productivity per worker when the number of workers is growing.

Frame-breaking developments in the fundamental sciences will probably be concentrated in computers, genetics, and nanotechnology; those would enable new paradigms in everyday life. My first choice would be a superbattery or supercapacitor capable of safely and cheaply storing 300 vehicle-miles worth of electric potential in a volume approximately the size of a gasoline tank. I also like the idea of achieving decentralized electricity generation (every house has a regenerative H2 fuel cell connected to the grid), achieving the same thing in energy that the internet did for communication. Those are the first two that I would choose, but there are countless other potential breakthroughs that would also create new paradigms.

[Slappy Joe]

"Would we help productivity if we make our response to future terrorist attacks more proportional to the attack (unlike what we did after 9-11)?"

Past experience says "no." During the Clinton years, the US engaged in proportional responses to Al-Qaeda attacks, and we were rewarded with increasingly bold attacks, culminating in 9-11. After abandoning the "proportionate response" doctrine, Al-Qaeda's attacks have since been aimed primarily at civilians of nations that continue to embrace "proportionate response," with attacks on US troops (who are much better equipped to fight them off with minimal casualties) a distant second.

Sure, disproportionate response doesn't make the believers in "proportionate response" any safer. It's not supposed to. You could abandon the "proportionate response" doctrine, but I'm guessing you're too closed-minded for that.

So, sucks to be you! Enjoy your terrorism, you've earned it!

[Bob]

Thanks for the response, Steve. I will try to send some more time at the BLS site.

It appears though that the "service" economy could skew some assumptions. The BLS acknowledges that revenue per employee is about the best they can do since they can't measure the number of beds made in a hotel, for instance.

My own experience in a segment of a roughly $300 billion industry (building energy and energy systems) reflected the inability to measure productivity in unit costs because we did not produce a unit. We used revenue per employee and COGS per COGS employee. Since it is a labor intensive business we hit the wall on productivity improvements. We just couldn't wring out any more time economically. So, productivity stalled. I'm not sure how it could be improved even with technology, which we used a ton of. Clearly, compounded rates of even 3% were not realistic.

I agree with you in spades about energy as THE problem to be solved and the one that needs to be the most frame-breaking if we are to get we need to be and ensure a prosperous future for your granddaughter.

[Nathan Hale]

Slappy Joe,

Your assertions about the Clinton administration engaging in proportionate responses to Islamic terrorism are wrong. The Clinton administration not only failed to strike back decisively, thus emboldening the Moslem terrorists, it even declined to take Osama bin Laden into custody when presented with the opportunity.

You might try reading what bin Laden and other Islamic terrorists have written on the subject. They say that America's weak responses encouraged them to move forward with their plans to carry out attacks in our country.

To paraphase the question of the post, "Would knowing what you're talking about before you open your mouth make you less embarrassed about your ignorance?"

[Jim Glass]

I decided to go thru the data to figure just *how much* of a productivity increase we'd need (starting now!) to keep the cost of SS and Medicare the same in 2030 as today in GDP terms (thus avoiding tax increases, etc., to provide the cash flow to pay for them), using the cost projections for these programs from their trustees.

The result was about a 60% increase above the last 40-year average.

Alas, a 60% increase is, as they say, "nontrivial".

Double alas, the compounding problem is this: *nobody really knows* what increases productivity, so nobody knows what to do to increase it (much less by 60%!).

There are lots of good ideas to increase welfare and wealth as one-shot deals -- but that's not *at all* the same thing as increasing systematic productivity growth that carries over year-to-year.

E.g., looking at the options under Steve's "$64 trillion question", simplifying the tax code would certainly be a very good idea that would help move the economy up a step to a higher level, once. So we should do it. We'd all be better off for it.

BUT there is no reason at all to think that it would lead to the systematic increase in successful innovation that leads to a sustained rate of productivity growth year-to-year for a generation. And it's pretty much the same for all the other good ideas.

A sustained increase in productivity on an economy-wide scale seems to require an invention such as "computer science" followed by 30 years of waiting and development for it to bear fruit, or the creation of an organization such as Wal-Mart.

But *nobody knows* where these come from, how to separate them from other new technological inventions and start-up businesses, or how to predict their development. And attempts to force their development through governmental (i.e. politically driven) industrial policy surely can *reduce* national productivity growth through failed programs.

So, while I certainly root for programs to increase productivity as much as anyone ... what to do???

And 60% is one whole lot.

[Iqbal Latif]

>
Causes as to why in ‘pre-Biblical times productivity was less that .01% annually.’

‘Productivity growth’ is a function of freedom and pluralism in a society…A comparison of pre-renaissance dark ages and post renaissance progress of human society especially the western civilisation in Europe are clear indication of a huge jump in productivity as a result of freedom accorded to minds.

Wealth in society without knowledge is injurious.To a society that is not in the fore front of research and development is a society that stalls and becomes stagnated, some societies may appear wealthy but in absence of knowledge based productivity are stuck in time.

Afghanistan and Saudi Arabia, one an impoverished land locked country and the other an oil rich country with sizeable reserves are both suffering with low level of knowledge based productivity increases. Their GDP improves but as a direct result of 'commodity' price increases, as the demand in the west for ‘drugs and oil’ increase so is the GDP of Afghanistan and Saudi economy multiplies. However, the bottom line is that without freedom of mind both nations are stuck in stone age.

>

Productivity definitely increases exponentially, from present average levels of 3% annual growth, a connected world moving towards a new super self consciousness will definitely have far higher levels of growth of productivity, in next fifty years expecting a 5% annual growth of levels productivity is conservative in my two cents worth.

>

War and terrorism has a direct impact on global productivity. Medieval minds who plan obliteration are 'net destroyers' of human advancement. To use planes full of innocent human beings and to help bring buildings down in crowded spaces need no appeasements. Those who use planes designed for peaceful transport as ‘guided missiles’ deserve a response proportional to their huge unproductive abilities. Shifting the theatre of war from '1 Liberty Plaza' to downtown Kandahar or around caves of Waziristan is the most balanced response one can envisage. The vandals at the door of Rome in few centuries were only possible when much earlier on Augustus decided to withdraw from the doctrine of external defence of the Empire borders across Rhine and Danube. The vandals today can encroach on the door of age of wisdom without impunity the transport links provide them the ease and facility, the unseen nature of the enemy is a dire threat. In this undeclared state of global war exporting the war to their own neighbourhood is the best defence.

The decay of a society begins when 'appeasement' with vandals is encouraged. The problems with wining over unseen terror outfit is that the ‘plans’ killed in embryonic stages are rarely ever seen as credible dangers, if 911 was nipped in the bud we could have seen a far bigger attack in next few years may be with far bigger repercussions, if similar action would have been taken post African bombing or post Cole who could say that 911 would have materialised, today for last 6 years the inability of Alqaeda to penetrate through homeland defences is the greatest success of the 'tongue in cheek' disproportionate response.

The ability to stop terror plans in their infancy is the biggest benefit of a disproportionate response, unfortunately for a public set on instant gratification and ‘Rambo’ kind of winnable war movies the unseen story behind the scenes are no achievements.

Free minds reflect growth close and productivity increases wheras close minds lead to destruction and stagnation.