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Innovation's hidden impact on the economy

Productivity is difficult to measure and even harder to predict. Technological innovations have changed the way people work, but the metrics that measure economic growth haven't yet evolved to capture new productivity sources.

Many forecasts are calling for a prolonged slowdown in the US economic growth rate, driven by the twin forces of demographic decline and stagnant worker productivity. It's undeniable the workforce is aging. With baby boomers retiring, the available pool of workers is growing more slowly than in previous decades. However, labor productivity may not be as grim as metrics appear to indicate. In fact, there's good reason to believe that innovation is causing productivity to climb faster than official GDP measures can capture.

Productivity peaks and valleys

From 1900 to 1973, waves of industrialization and urbanization generated 3 percent to 4 percent productivity gains almost every year. In 1970, Congress passed the Clean Air Act, which established regulations that led to improvements in the quality of the environment, but also slowed business activity. As the regulations took effect, labor productivity growth declined to about 1.5 percent annually from 1973 to 1995.

The telecom and information technology (IT) boom helped boost productivity growth to a 3 percent annual average between 1995 and 2004; but since then, the workforce has entered a dramatic and sustained productivity slowdown. Since 2010, labor productivity has increased at a 0.5 percent annual pace.

This slowdown is puzzling. As a leaner, more efficient, better educated and more technologically sophisticated workforce emerged from the recession, a productivity surge should've ensued. Perhaps productivity has rebounded more than the metrics indicate, as official GDP measurements don't appear to fully capture the productivity gains of the digital era.

Five invisible sources of productivity

  1. Free digital services: It's difficult to measure the value of free online services that are now so easily accessible on smartphones. While such activity is primarily supported by advertising revenues—similar to radio and TV programming–the advertising costs associated with these free digital services likely aren't fully incorporated into the retail price of consumer goods captured by GDP measurements.
  2. E-commerce: Official measures may also be missing a significant share of e-commerce currently being subsidized by company shareholders. Perks like free delivery may not appear on customers' receipts, but investors in large online retailers clearly believe such subsidized incentives create value because stock prices rise even though these companies have yet to produce much in earnings.
  3. The gig economy: Today's sharing economy is creating new consumer markets, as evidenced by companies such as Uber, Lyft and Airbnb. But surveys of consumer spending are likely missing some of the services being exchanged in the gig economy.
  4. Intangible investments: The official measure of GDP includes some types of intangible business investments, such as mineral exploration and scientific research and development. But other intangible investments aren't measured, including employee training, brand equity and organizational capital. As a share of total capital spending, intangible investment is growing about twice as fast as other categories of business investment, so when a large share of investment activity isn't counted, worker productivity will appear to slump.
  5. Digital depreciation: The steadily falling price of computing power complicates attempts to measure the true value of IT investment. Prior to 2004, the Bureau of Economic Analysis (BEA) used Intel's back catalogue to determine how quickly the price of digital hardware was depreciating. But Intel has since stopped discounting its obsolete chips, and many analysts believe that improvements in IT equipment are no longer fully reflected in the BEA's figures.

When the value of new computing technology is underestimated, the apparent productivity of the entire IT industry is diminished. As a result, official labor productivity figures are likely missing the gains from one of the country's most innovative sectors.

A bright economy

Productivity growth is difficult to predict. It's largely driven by technological progress, which occurs in uneven bursts as incremental advances give way to market-changing breakthroughs. The present pace of labor productivity growth likely has little bearing on its future direction. Already, fields like artificial intelligence and robotics are reshaping a handful of industries, and they'll likely continue to revolutionize the way the workforce operates.

With entitlement programs such as Social Security and Medicare reliant on GDP growth to sustain their funding, the US will need a more productive workforce to support its aging population. While the current metrics point to a disappointing trend, the accelerating pace of innovation will likely lead to new jobs and better living conditions. And as GDP measurements evolve, we'll likely see a more positive productivity trend emerge.

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