Retirement

The U.S. Economy May Be Primed For An Innovation Boom

Faster productivity growth in the U.S. economy provides many benefits such as faster wage growth without adding to inflationary pressures. It also hinges on a few key factors such as public infrastructure investments and private business investments in updated facilities and new technologies. The U.S. economy has seen an acceleration in productivity growth – how output per hour has changed – over the past year. This is atypical for this stage in a business cycle. That is, productivity growth has unexpectedly accelerated. This acceleration could reflect recent trends in public and private investments as well as in employment. Given that these trends have continued, albeit in slightly different forms, there is a good chance that productivity growth will continue at a healthy pace.

Faster Productivity Growth At The Heart Of Rising Living Standards

Productivity growth is at the core of an improving economy. It basically measures whether people and businesses can achieve more and better outcomes with the same resources, for instance, in the same amount of time at work. In the current environment, this will mean a quicker transition to a green economy, for instance. Moreover, faster productivity growth provides the resources for faster wage growth without stirring more inflationary pressures. It also makes it easier for workers to support an ageing population. And, it results in faster economic growth and thus faster revenue growth and smaller government deficits than otherwise would be the case. In short, faster productivity growth lays the foundation for healthier and more stable economic outcomes.

Right now, it looks like the U.S. economy is on healthy trajectory toward stronger productivity growth. The Bureau of Labor Statistics reports that output per hour – the key measure of labor productivity – increased by 3.2% in the last three months of 2023. This is down from a remarkably strong annualized 4.9% in the third quarter of 2023 and a still strong 3.6% in the second quarter of last year. When compared to a year earlier, labor productivity grew at 2.7% from the fourth quarter of 2022 to the fourth quarter of 2023. Year-over-year productivity increases have now accelerated for five quarters in a row (see Figure below).

The Ingredients For Faster Productivity Growth All Emerged Since 2021

One possibility is that the current bump in productivity followed from greater usage of new information technology. This requires technological advances, which have happened relatively rapidly in recent years, as MIT researchers pointed out years ago. Examples are more widespread use of artificial intelligence (AI), greater cloud computing power and breakthroughs in biomedical research to name just some recent technological advances.

Further, the pandemic requirements of social distancing led to more widespread adoption of new technologies. This was apparent in some business investment trends. In 2021 and 2022, private businesses substantially increased their investments in computers and peripherals, other equipment, including medical equipment, software and research and development, among others. Those categories — information processing equipment and intellectual property products — accounted for 92.7% of the 4.4% increase in private business investment in 2021 and for 90.3% of the 3.81% increase in 2022.

Moreover, businesses have incentives to continue the implementation of new technologies in the face of strong wage growth. And, as Skanda Amarnath at Employ America points out, a quick return to full employment thanks to various supporting legislative measures meant that employers had a lot of experienced workers on hand to boost productivity.

Massive economic upheaval associated with the pandemic created substantial noise and obscured trends. But, this started to change in the second half of 2022. Quarterly productivity growth started to turn positive, culminating in quarterly (annualized) productivity gains of 4.9% in the third quarter of 2023. The positive trend continued at the end of 2023 and productivity is now above its pre-pandemic trend.

Public And Private Investments Laid The Groundwork For Faster Productivity Growth

Other investments in the past few years likely laid the ground for further productivity gains in the near future. Public infrastructure spending is one critical ingredient into faster economic and productivity growth. This form of government spending has grown especially fast since the fourth quarter of 2022. All levels of government – federal, state and local – increased their spending on structures such as buildings and roads, equipment such as computers and school buses and intellectual property such as budgeting software. State and local government investments in structures alone made up more than a quarter of overall government spending growth in the last three months of 2023. These substantial public investments can contribute to faster productivity and economic growth over the long term.

Though they have grown at relatively slow rates in recent quarters, private sector investments could still help to also bolster productivity growth. Private business investment spending has been led particularly by spending on manufacturing plants. Manufacturing has traditionally been a key source of productivity growth. The key investments made in this sector could thus further support strong productivity growth in the future.

Legislation Helped Speed Up Public and Private Investments

Public policy has aided many of these developments. The bipartisan Infrastructure Investment Jobs Act, for example, provides substantial amounts for a wide variety of projects. The Inflation Reduction Act set a clear marker for expanding green energy generation and adoption. The federal government’s long-term commitment to changing the energy mix of the U.S. economy helps to create certainty for the private sector and thus can lead to a boost in private investments as well. In the end, crucial investments happen because the private and public sector work together towards a more innovative future.

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