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US Productivity Key Issue At Annual Economist Conference January 8, 2007

Posted by notapundit in Economic News.
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CHICAGO (Dow Jones)–The program for annual meetings of the American Economic Association and other groups making up the Allied Social Sciences Associations held over the weekend ran around 250 pages.

Sandwiched between sessions on such esoteric topics as “Religion and Fertility,” “Modeling Bounded Rationality in Games” and “Great Ideas for Teaching the History of Economic Thought” was discussion of what may be the hottest issue for academics and monetary policymakers alike in 2007: productivity.

The topic isn’t new, but the circumstances have changed as a growing number of economists contend that productivity is entering a third – and decidedly weaker – phase in just over a decade.

The 1995 to 2000 period was the start of the New Economy expansion of productivity, when average annual productivity almost doubled from its average rates in the 1970s and 1980s to about 2.7%.

Surprisingly, productivity further accelerated from 2000 to 2005 to over 3% even when high technology slumped, as companies were better able to squeeze more efficiencies out of their previous investments in information technology.

But productivity stalled in recent quarters, and the question facing economists at the AEA meetings was whether those are just temporary blips or the start of a new, slower trend that combined with weaker labor force growth will dramatically cut the economy’s growth potential and make it tougher for the Fed to lower rates in response to any economic downturn.

Speaking at the AEA conference, New York Fed Economist Kevin Stiroh argued that productivity should stay near its post-1995 levels. In a conference paper co-written with Harvard University Economist Dale Jorgenson and Mun Ho from Resources for the Future, Stiroh wrote, “although (information technology) has diminished in significance since the dot-com crash of 2000, we project that private sector productivity growth will average around 2.5% per year for the next decade.”

The economists said information technology “will continue to impact the U.S. economy” and that other forces like flexible labor markets, deep capital markets and robust competition will keep driving innovation.

That would be welcome news for Fed officials, since such rapid trend productivity growth would mean that the current economic slowdown will create disinflationary slack. In remarks last year, Fed Chairman Ben Bernanke echoed the relatively upbeat conclusions of Stiroh.

But the minutes of the December Fed meeting released last week suggest there’s some uncertainty within the Fed about where productivity is heading. “The growth of structural labor productivity could be weaker than currently thought, helping to reconcile the steady growth in employment with more subdued advances in spending and output,” the minutes stated.

Northwestern University professor Robert Gordon outlined the skeptical view at the AEA conference. He sees productivity over the next couple of decades at just 2.1% – better than the 1970s and 1980s but below the past decade. And Gordon said that 2.1% growth rate “may be too high.”

Gordon places the U.S. economy’s potential growth rate – calculated by adding annual labor force growth to productivity – at just 2.5%. That’s well below the 3% to 3.25% growth rate that many economists peg for output potential. At the height of the New Economy boom, economists thought the growth potential was as high as 3.5% to 4%.

The question is more than just academic.

If the economy’s growth potential is just 2.5% as Gordon thinks, than the current slowdown is unlikely to open much slack. If it’s 3% or a little higher, then it would likely push joblessness higher and dampen price pressures, allowing the Fed to cut rates.

And the growth potential issue gained considerable traction in 2006, as Fed staff economists twice cut their estimate of U.S. potential and brought greater awareness to the role Baby Boom retirement will have on labor force growth.

Speaking to the AEA conference Friday, Chicago Fed Economist Daniel Sullivan said labor market trends may shave as much as 0.6 percentage points off the economy’s speed limit. He calculated that 0.45 percentage points of that comes from slower labor force expansion and 0.15 percentage points is from reduced labor productivity as more experienced Baby Boomers exit the workforce.

In a sign of how that type of academic analysis by Fed staff translates into monetary policy, Sullivan’s boss, Chicago Fed President Michael Moskow, gave a speech down the street from the AEA conference on Friday in which he echoed many of his economist’s views.

“The contribution of labor to potential output growth may have declined by a bit more than half a percentage point since the late 1990s,” Moskow said.

Moskow is a voting member of the FOMC this year.

A slower potential will likely color the way Moskow, for one, looks at economic data. He estimates that given slower potential and labor force trends, the number of new jobs per month needed to absorb new entrants and keep the unemployment rate steady is just 100,000, down from 150,000 just a few years ago.

So, an official like Moskow would likely view last month’s payroll gain of 167,000 as particularly strong and not representative of an economy in need of a lift.

But economists Jack Triplett and Barry Bosworth of the Brookings Institution, a think tank, gave reason to view the latest jobs data with optimism for productivity.

The service sector – once thought to be very low in productivity – created 178,000 jobs last month, offsetting a decline in the traditionally high-productivity manufacturing sector. According to Bosworth and Triplett, much of the economy-wide efficiency gains since 1995 actually came from services.

Thus, the idea that productivity gains came from one-time technological changes “is not consistent with the U.S. industry productivity data and has led to mistaken analysis and too pessimistic forecasts,” they wrote.

By Brian Blackstone; Dow Jones Newswires

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