It seems so simple. Every student in Economics 101 memorizes “productivity is equal to the output per unit of input” before the quiz. What could possibly be controversial about that?
There is a growing controversy over productivity, though. It mostly involves economists at this point, but it has such direct implications for policy decisions that it is capturing the interest of more and more real people.
For economists, the concept of productivity, and controversies over it, aren’t quite as old as economics itself, but very close to it. And the issues they raise are as real as today’s headlines and tomorrow’s paycheck.
Adam Smith, who is considered to be the “Father of Economics,” published his “Wealth of Nations” in 1776, and attributed productivity improvements to the division of labor (specialization) and to technology. There is nothing wrong with Adam Smith’s belief about the source of productivity and it remains the basis of today’s productivity measurement. The formula hasn’t changed, though, while the economy has.
If we can imagine a video of the U.S. economy from 1776 to the present, what we would see at the beginning would be a system that was almost entirely devoted to the production of goods, through agriculture and manufacturing. Fast forward to the present and what we see is an economy in which the production of agricultural and manufactured goods is now smaller than the services sector.
What we would conclude is that the agricultural, manufacturing and other physical good sectors had experienced such phenomenal increases in productivity that they allowed the growth of a service sector that devoted itself to other aspects of human life, from health and education to finance, government, entertainment, and sports.
It is difficult even to agree on what productivity means in many activities in the service sector. We are still struggling to come up with a controversy-free definition of what productivity means in the health care sector, for example, and that area now represents nearly a quarter of our economy.
The macroeconomic implications of productivity changes were taken up by the economic thinkers Adam Smith influenced. But while he had given the class structure implications of his theory only passing recognition, Karl Marx made class conflict the center of force driving economic development. He believed that the adoption of more productive technologies, which capitalism was so good at, would eliminate jobs and eventually create what he called, “vast army of the unemployed.”
We hear echoes of Marx’s theory in today’s concerns about technology and our measurements of productivity. They are at the heart of the latest econo-fad, the Universal Basic Income (UBI). Supporters believe that an automatic payment from the federal government would be a more efficient way of smoothing out the jobs peaks and valleys caused by technological change and foreign competition. At its heart, though, are concerns that technology and productivity gains are a threat to jobs.
The current controversy surrounding productivity was initially caused by the fading of its traditional links to investment and to wages. Economists explored the possibility that investments in information technology didn’t have the payoff in productivity gains that other forms of investments have. That possibility, of course, tapped into a long-standing belief of some economists – and Silicon Valley — that the productivity metrics understated the impact of improvements in information technology.
Metrics are at the center of the controversy over the relationship between productivity and demand. Productivity is very sensitive to price changes, for example, because output is measured in dollars and cents. Otherwise, we would end up, literally and figuratively, trying to add apples and oranges. A change in demand changes productivity raises or lowers productivity even though the technology and the workers’ skills haven’t changed at all. In addition, technology improvements tend to drive prices down in the long term, which would lead to our understating productivity
The central challenge in measuring productivity, however, is the age of the definition and the formula. It is simply too physical. When Adam Smith examined the economy, it was primarily made up of goods – agricultural or manufactured. These were things that you could see and touch. They were easy to measure in terms of quantity, weight, gallons, and similar scales. This is not the case with the service sector economy which is now the largest part of our economy. It also lacks a time dimension which presents a barrier to understanding as well as a clash with the GDP accounting system whenever a multi-year project – typical in many information technology – is involved.
The controversies are not likely to disappear soon. And what they are telling us is that our conventional thinking about productivity isn’t accurate enough to support economic policy decisions. We’ve got to add some good sense, too.
James McCusker is a Bothell economist, educator and consultant.