The productivity surge of the 2020s
- Productivity growth over the past decade has been disappointing but we do not expect that to continue
- As labour supply shrinks and automation increases, productivity should increase once more
- Stronger productivity may lead to more accommodative monetary policy and provide a meaningful boost for equity markets
Productivity is an important source of economic growth and competitiveness. For the past decade or so, productivity growth in the developed world has been hugely disappointing.
Average annual per capita output measures the amount of goods and services produced per person in an economy in a year.
For the two decades leading up to 2008, the average annual per capita output for the 38 member states of the Organisation for Economic Co-operation and Development (OECD) expanded at 2.7 per cent per annum. Since then, the pace has slowed to 0.9 per cent per annum.
That has led many to argue that we are in an era of economic stagnation.
While this may turn out to be right, we think it is important to consider an alternative perspective. Here, I set out an argument for why the 2020s could deliver much stronger productivity growth than many expect.
Labour supply will shrink
An important explanation for the relatively muted productivity growth of the past decade was spare capacity within the economy: there was no shortage of labour, both domestically and overseas. This reduced the incentive for companies to invest in labour-substituting technology that could fuel productivity gains.
But this is changing. Across developed economies (and many emerging markets too) populations are ageing rapidly and the falling birth rates in recent years mean that the pool of new workers is not growing sufficiently to replace those dropping out of the workforce.
Across the OECD nations, the working-age population (aged 15-64) will fall by around seven million people over the decade to 2030.
At the same time, rising wages and growing geopolitical tensions make it less appealing to offshore jobs to countries such as China.
We think companies will increasingly adopt automation and technology to offset the impact of tighter labour markets. Indeed, this is already happening. Acemoglu and Restrepo (2021) have shown a clear relationship in recent years between the rate of population ageing and the extent of robot adoption across countries.
The capability of technology is broadening
Stanford University’s The AI Index Report measures the latest trends in artificial intelligence (AI). The 2022 report shows that AI performance now matches or exceeds the performance of humans both on image recognition and language understanding tests. Robotics technology is rapidly improving too.
Some of the most important recent developments include:
- the increased use of AI which allows robots to handle unsupervised, unexpected situations;
- improvements in sensor technology, which increase robots’ awareness of the environment; and
- combining robotics with cloud technology.
Better performance has led to wider adoption. For the first time in 2021, US robot orders for automakers and their parts suppliers did not form the majority of the total robot installation. Starting from a low base, demand rose by 72 per cent from life science and pharmaceutical companies, and by 32 per cent from consumer goods companies.
Automation is rapidly making inroads into large areas of the economy that were until now largely reliant on human labour. For example, Eggleston et al (2021) studied 860 Japanese nursing homes and found that by 2017, 26 per cent had adopted service robots.
The fast-food industry has also seen several recent advances in automation, from AI software taking drive-through orders to robotic cooks. A Boston Consulting Group project noted that with increasing capability and demand, professional services will become the dominant user of robotic technology by 2030 with a total market of $90bn in its base case, against $80bn for industrial and logistics applications (a growth rate of nearly 20 per cent per annum).
Productivity growth is not a straight line
Viewed in a longer context, productivity growth is cyclical: periods of stagnation often give rise to rapid and unexpected growth spurts. The chart below shows US productivity growth as a 10-year trailing average. After a post-war spurt, growth slowed substantially in the 1970s and 1980s before rebounding in the 1990s and early 2000s. It has since tailed off again.
US productivity growth (output per hour), 10 year trailing average
There are good reasons to suspect that productivity does not follow a linear upwards or downwards trend. If we accept that innovation (in technologies and processes) is a key contributor to productivity growth; and that discovery and adoption of innovation is a non-linear process, then productivity growth ought to show no obvious historic trend. Brynjolfsson et al (2019) have described the process of technology adoption as a ‘J curve’, in which take-up is initially slow but rapidly accelerates as processes adapt to benefit from the opportunities created.
Robotics could be one such productivity revolution. An Oxford Economics (2019) study of 29 countries estimates that a 1 per cent boost to the number of robots per 10,000 workers increases GDP by around 0.1 per cent. With robot adoption set to soar, in an optimistic case, productivity growth could again approach 1990s levels.
What are the implications of stronger productivity?
Productivity is inherently disinflationary: it expands potential output and weakens the relationship between a tight labour market and inflation.
Faster productivity allows wages to rise without creating an inflationary spiral. Put simply, if productivity runs at (say) 2 per cent rather than 1 per cent, it implies that the US Federal Reserve could hit its inflation target of 2 per cent with nominal wage growth of 4 per cent. That would allow a more accommodative monetary policy than if wages outstrip productivity.
It might also be a meaningful boost for equity markets. It should help maintain high levels of corporate profitability, offsetting headwinds from deglobalisation and rising labour costs. And it will create opportunities for those companies able to take advantage of the rising demand for technology.
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