Productivity in 1997-2000 and the Debate on the New Economy and the New Paradigm
    Until 1995, productivity growth in the U.S. was mediocre (1.4% in 1990-95 and 1.3% in the 1980s) and close to levels observed in past decades. Since the labor supply was growing at about 1% per year, this implied that the maximum long-run growth rate of the economy was a modest 2.4%, the historic average for 1980-95.  Then, something changed: in 1996 and 1997 productivity growth started to pick up
as data showed a significant increase in the rate of productivity growth. For example, data for the third quarter of 1997 showed that productivity was growing at a annualized rate of 4.0% in the business sector and a whopping 9.3% in the manufacturing sector. While the annualized growth rate data might be distorted by a particular good quarter, the actual quarter-on-quarter annual rates of growth showed similar large increases of productivity growth: the actual productivity growth between the third quarter of 1996 and the third quarter of 1997 was 2.4% for the business sector and 4.6% for the manufacturing sector, well above the dismal rates of 1.0% observed in the early 1990s. These new data led a number of authors to argue that we had entered in a new era of sustained productivity growth; one heard a lot of talk about a  "New Economy" where a "New Paradigm" of high growth and low inflation holds.
The data for the 1996-2000 next confirmed this shift in trend productivity growth. Labor productivity averaged 2.5% per year in 1996-1999;  next, in 2000 productivity growth accelerated to the exceptional 4.3%. Lately, the slowdown in economic activity in late 2000 and the risk of a recession in 2001
have led to a slowdown of productivity growth in Q3 and Q4 of 2000: 3.0% and 2.4% respectively.
  There has been a broad debate on these data and trends. Some are very optimistic and argue that the investments in Information Technology (IT) and the New Economy have led to a sharp increase in the long-run rate of productivity growth, close to a 3% or more. Since labor supply is growing by about 1% per year this would imply a sustainable long run growth rate of the economy of 4%, well above the recent historic average of 2.4.%. They see the recent slowdown in Q3-Q4 of 2000 as a temporary phenomenon.  Others are more cautious and skeptical and argue that, while the long run growth rate of productivity
is now higher than the average in the 1980s and 1990-95 period (1.4%) because of the New Economy, it may not be greater than 2.0% per year as the figures for 1996-2000 are biased by the excessive investment in IT and the excessive growth rate of the economy in that period; i.e. while the New Economy is for real, it has been excessively hyped up.  They thus argue that the maximum sustainable rate of growth of the economy has gone up from 2.4% to a figure close to 3% (2% productivity growth
and 1% labor supply growth), well below the 4% suggested by the optimist camp.
 

The slowdown in productivity growth in the 1970s and 1980s
 After over two decade of high productivity growth in th 1950s and the 1960s, we observed a significant slowdown of productivity growth in the 1970s and 1980s following the first oil shock in 1973. The debate on the causes of this productivity slowdown has turned into a puzzle as the causes of the worlwide slowdown have not been clearly identified. The following two tables show the extent of this productivity slowdown.

Table 1. Total Factor Productivity Growth Rate

1950s 1.4% per year

1960s 1.4%

1970s 0.1%

1980s 0.5%

1990-95 1.7% (0.9% with chain-weight method)

Labor Productivity Growth Rate

1900-1970 2.3% per year

1950s 3.0%

1960s 2.6%

1970s 1.1%

1980s 1.3%

1990-95 2.2% (1.4% with chain-weight method)
 

Several explanations of the slowdown has been suggested but none has been found to be fully satisfactory (see Krugman "The Age of Diminished Expectations" Chapter 1 for a detailed discusssion):

1. Energy crisis in the 1970s (1973 and 1979 oil shocks).

2. Exhaustion of the post-W.W.II technological boom.

3. Low investment and savings rate.

4. High taxation of savings.

5. Excessive government regulations.

6. Low rate of public investment in infrastructures.

7. Decline of R&D investment.

8. Sociological explanations.

9. Decline in quality of education.
 

The 1990s puzzle.

The data for the 1990s have led to a new productivity puzzle. Until the end of 1995, when the fixed-weight system was being used to measure GDP and productivity, it appeared that there was a major resurgence of productivity in the 1990s: total factor productivity grew at a 1.7% per year rate while labor productivity grew at a 2.2% yearly rate. It appeared that a decade old (starting in the 1980s) process of corporate restructuring, reengineering, down-sizing had finally borne its fruits and led to a major resurgence of productivity in the 1990s.

However, the switch in 1995 to chain-weight metohd for measuring productivity changed drastically the picture: the new chain-weight data showed that in the 1990s total factor productivity grew at a dismal 0.9% per year rate while labor productivity grew at a 1.4% yearly rate, not much above the 1970s and 1980s rates. So the great resurgence of American productivity in the 1990s suddenly disappeared overnight by a statistical wand.

These numbers looked dismal because many economists believed that the process of corporate restructuring, reengineering, down-sizing of the last decade, together with the development and adoption of computers and information technologies in the corporate world, had led to a major resurgence of productivity. The new chain-wighted numbers seem to imply that such productivity resurgence never occurred.

  In the debate that ensued in 1996, there were essentially two views.

On one side there were those, like Paul Krugman, who argued that the new measures of output and productivity were substantially correct and that the productivity benefits of the Information Revolution had been overstated. See his views in his February 1996 NY Times contribution to the debate.

On the other side, those like Stephen Roach (Chief Economist at Morgan Stanley) arguing that the new chain-weight method underestimated output and productivity because, among other reasons, of mismeasurement of the growth in productivity in the service sector. See his rebuttal to Krugman's view and contribution to the debate. On why computers might not have led to a major increase in productivity growth see also a recent NYT article.

The debate in 1996 on productivity was clearly related to the other debate on whether output and CPI inflation were mismeasured. The debate on productivity is also linked to the controversy on whether the economy is growing too fast and risks to generate inflationary pressures, the debate on the sustainability of the process of restructuring and down-sizing of corporate America and its effects on the income and wealth distribution..

The 1996 debate on productivity took a twist in May when Roach changed substantially his view on whether there was a structural increase in productivity growth in the 1990s. See his three revisionist pieces: MSEF May 8, MSEF May 9, MSEF May 14.

The switch in Roach's view was consistent with his strong views about the risks of a resurgence of inflation in the U.S. His argument on inflation risks was based on three points: 1) the productivity growth rates seen in the early 1990s were not sustainable because they were based on pursuit of "cost-cutting efficiency" rather than permanent "productivity growth"; 2) therefore one could expect soon a "worker backlash" that would drive up wage costs; 3) this wage backlash would therefore lead to higher inflation in 1996-97 as the economy was growing at a rate faster than its potential productivity.

The debate on whether the output and productivity of the service sector is correctly measured has also reached the Federal Reserve. In the Minutes of the September 24, 1996 meeting of the FOMC, several FOMC members expressed such an opinion that has been endorsed in public by the Fed Chairman Greenspan. Also, the fact that low unemployment and full capacity has not been associated with with higher inflation has been explained in part by the fact that productivity growth is likely to be underestimated. In words of the minutes:

"Widespread reports suggested major gains in productivity in numerous industries, induced in recent years by business restructuring and related activities and by large capital investments that had introduced increasingly productive equipment. Although currently available measures of productivity for the economy as a whole showed only weak gains, sectoral disaggregation of the data gave reasons to question the productivity measurements. Productivity had increased fairly sharply in manufacturing, and the slowdown in overall productivity since 1973 had been concentrated in the service areas of the economy. Indeed, measured productivity in noncorporate businesses--largely services--had displayed a negative trend for many years. This result was implausible and suggested considerable error in estimating output and prices for many services. Consequently, it was likely that actual productivity growth was higher than the current measures indicated. By the same token, the rate of price inflation was lower than had been reported, consistent with the findings of a number of studies of distortions in published price data."

This new Fed view of productivity and the low inflation risks in the economy has been challenged by Roach who has been the a strong proponent of the view that inflation is not dead and that we will probably observe a resurgence of inflation soon. Read his critique of the new Fed productivity play, his view of why productivity is on the wane and his skeptical view of the Slifman and Corrado study and Greenspan's "new paradygm".

For a different view, see the NYT article on Dec 1, 1996 on how mismeasurement of CPI biases downwards our productivity & real wage measures.
 

New data on productivity growth in 1996-97 and the debate on the New Economy
   This debate was partly settled in the following years.  In 1996 and 1997 productivity growth started to pick up as data showed a significant increase in the rate of productivity growth. For example, data for the third quarter of 1997 showed that productivity was growing at a annualized rate of 4.0% in the business sector and a whopping 9.3% in the manufacturing sector. While the annualized growth rate data might be distorted by a particular good quarter, the actual quarter-on-quarter annual rates of growth showed similar large increases of productivity growth: the actual productivity growth between the third quarter of 1996 and the third quarter of 1997 was 2.4% for the business sector and 4.6% for the manufacturing sector, well above the dismal rates of 1.0% observed in the early 1990s. These new data led a number of authors to argue that we had entered in a new era of sustained productivity growth; one heard a lot of talk about a  "New Economy" where a "New Paradigm" of high growth and low inflation holds. The data for the 1996-2000 next confirmed this shift in trend productivity growth. Labor productivity averaged 2.5% per year in 1996-1999;  next, in 2000 productivity growth accelerated to the exceptional 4.3%.
 

The homepage on the New Economy on present an introduction to this recent debate.

For further data, information and discussion on the productivity debate, look into the Department of Labor home page on Quarterly Labor Productivity Statistics. The latest data on productivity growth are available there.