America's Labor Productivity Problems Began Years Before The Financial Crisis

John Fernald of the Federal Bank of San Francisco is out with a working paper that looks at economic productivity and potential output before, during, and after the financial crisis.

Fernald's biggest finding: labor productivity was slowing before the financial crisis.

Labor productivity, as defined by the Bureau of Labor Statistics, is output relative to labor hours used the produce the output. Basically, how much people work and how much they get done in that time.

The IT boom changed the workforce's productivity in a big way. Fueled by what Fernald calls, "the exceptional contribution of IT," labor productivity growth from the mid-1990s to the early 2000s broke its long-term linear trend line to the upside.

This chart below shows the broken trend.

And this broken trend shows that the financial crisis didn't materially affect labor productivity, which started declining before the 2007-2008 bursting of the housing bubble and subsequent crisis.

From Fernald (emphasis ours):

"A natural hypothesis is that the slowdown was the flip side of the mid-1990s speedup. Considerable evidence... links the [total-factor-productivity] speedup to the exceptional contribution of IT- computers, communications equipment, software, and the Internet. IT has had a broad-based and pervasive effect through its role as a general purpose technology (GPT) that fosters complementary innovations, such as business reorganization. Industry TFP data provide evidence in favor of the IT hypothesis versus alternatives. Notably, the euphoric, "bubble" sectors of housing, finance, and natural resources do not explain the slowdown. Rather, the slowdown is in the remaining ¾ of the economy, and is concentrated in industries that produce IT or that use IT intensively. IT users saw a sizeable bulge in TFP growth in the early 2000s, even as IT spending itself slowed. That pattern is consistent with the view that benefiting from IT takes substantial intangible organizational investments that, with a lag, raise measured productivity. By the mid-2000s, the low-hanging fruit of IT had been plucked."

Fernald also includes this chart, which shows where Congressional Budget Office's projected economic potential in both 2007 and 2014. The CBO's projections are shown against actual total-factor-productivity and GDP rates, as well as Fernald's own projection about where the economy might be headed.

Fernald's paper is long and extremely technical, but as Dietrich Vollrath notes at The Growth Economics Blog, the paper raises two important points to keep in mind: the Great Recession may be less "Great" than previously thought, and barring another IT revolution, labor productivity and resulting economic potential isn't what we once thought it could be.

(via The Growth Economics Blog)