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Why the decline in productivity is hurting wages

Posted August 29

The U.S. economy has suffered its third straight quarter of declining productivity. The last time that happened was in the 1970s. Economists say the slump is a major drag on wages that needs to be corrected to restore overall economic health. (Deseret Photo)

Terry Bishnell says her job at a food-and-drug store near Detroit has not changed meaningfully in recent memory. Products are trucked in, stocked and ultimately sold using the same technologies and processes that have been in place for several years.

Business runs fairly well, she says, but not any more efficiently than it did four or five years earlier. “I can’t think of one big change we’ve made in that time,” Bishnell said after work on a recent summer afternoon. She said the last significant change came five years ago with an upgrade to the inventory tracking software.

By extension, Bishnell’s hourly pay has hardly advanced. Her employer said its profits are only inching up and so it can afford only small annual cost-of-living raises. “I feel like I’m running in place,” she said. “I’m not getting any farther ahead.”

Bishnell’s is a familiar experience among many American workers in the wake of the last recession, as sluggish business investment in new equipment and facilities has resulted in disappointing worker productivity levels for years, including notably poor showings during the first half of 2016.

Economists say improving nonfarm business productivity — defined as the goods and services produced per hour by workers — is a vital driver of higher living standards because when Americans produce more efficiently, their employers are able to apply the savings to the bottom line. Companies that are increasingly profitable are better positioned to raise wages, and when Americans earn more they tend to spend more, fueling economic growth and helping to create a virtuous cycle in which companies generate greater earnings, invest more and continue to grow.

“At the end of the day, greater productivity means a better way of life for more people,” Lawrence White, an economist at New York University's Stern School of Business, said in an interview. “So this is a very important measurement of our economic health. Unfortunately, the trend has not been an especially good one.”

Indeed, the U.S. Department of Labor said this month that second-quarter business productivity declined at a 0.5 percent seasonally adjusted annual rate. The number of hours that workers logged increased faster than the level of goods produced and services delivered, meaning the average workplace lost ground on the efficiency front.

A disappointing trend

It marked the third straight quarter of diminishing productivity — it fell 0.6 percent in the first quarter of this year and 2.4 percent in the final three months of 2015. The U.S. had not recorded a three-quarter negative streak since the 1970s.

On an annual basis, productivity has held in positive territory, though it is well below the levels of previous eras. The Labor Department estimated 0.9 percent productivity growth in 2015, following a 0.8 percent advance the year before.

The average annual rate of productivity growth from 2007 to 2015 was 1.3 percent per year, about half the pace recorded from 2000 to 2007 and far off the long-term rate of 2.2 percent per year from 1947 to 2015.

“It’s not like we’re going down the toilet,” White said. “But we’re definitely not headed in the direction we’d want.”

What’s to blame? White and other economists say the answer is multifaceted. One piece of the puzzle is the simple fact that the current era lacks a major innovation to dramatically bolster workplace efficiently. Past eras were boosted by the advent of automobiles, of telephones, of computers. Productivity notably improved in the 1990s and early 2000s with the adoption of the Internet for substantially faster communication and delivery of information. The economy boomed and household incomes jumped.

To be sure, Raymond James chief economist Scott Brown said in an interview, recent advancements in mobile phone technology and various computer applications have helped many Americans do their jobs more efficiently. That contributed to the modest annual gains of the past couple years.

“But even there, we’ve largely exhausted the benefits from those advancements because the efficiencies they bring are already built into our workplaces. So a lot of the gains are behind us,” Brown added. That, he said, helps explain why productivity has begun to steadily decline in recent quarters.

What’s more, economists say, in the aftermath of the 2008 recession, the worst downturn in generations, many businesses have been leery of making significant new investments, fearing that the choppy economic recovery over the past several years could at any time derail and force them to make painful cuts. Brown said employers often make big investments only when they are confident that they will be able to capitalize on them for years to come.

“And they just aren’t confident,” he said. “At least not enough of them have that confidence.”

Bad news for paychecks

Economic growth and wage increases have both been tepid in the years since the last recession. Improvement on either front may depend upon productivity advances that, at the moment, appear elusive.

BMO Private Bank chief investment officer Jack Ablin, who examines labor force trends, noted that employers can of course raise wages without making productivity gains. But unless they want to cut into profits to fund pay increases — which many are loathe to do — most would have to raise prices to pay for higher wages. Higher prices would offset the benefits of higher wages.

In an email, Ablin laid out his vision for how higher productivity should help both employers and their workers:

“If a company achieved 5 percent more output from their existing workforce, all other things being equal, they should be gladly willing to offer a 3 percent wage increase and pocket the 2 percent difference,” he said.

To be sure, as technology advances, there is potential for major innovation that could alter the productivity landscape. Pricewaterhouse Coopers notes that expectations are mounting for so-called service robots. The corporate consultant says in a report that if businesses such as hotels were to use robots to clean rooms and hallways, their employees could focus on customer interaction and developing new revenue-generating services and more efficient ways of delivering them.

But such technology is still in the works, and hastening both its development and eventual use would require businesses to make it known they would invest in such technology or other advances, and that is not happening at most companies. Ablin noted that business spending contracted at a 2.2 percent annualized rate in the second quarter. Additionally, inflation is tame amid the slow economic growth of the last few years, meaning even modest price increases have proven difficult for many companies to impose on their customers.

“Nowadays,” he said, “scant productivity and low inflation leaves little room besides corporate profits to fund wage gains.”

But that is not something most businesses can afford to do for any extended period. Companies will either have to take risk in the short term and invest in new equipment, software and other technology to bolster productivity to benefit their own long-term outlooks and that of their employees. Or they can hope that a world-changing invention ushers in a new era of efficiency.

But waiting and hoping is hardly a business strategy. And, as Ablin points out, weak wage gains over several more years could result in a perpetually listless economy. “This trend can’t go on indefinitely,” he said.

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