Markets and Economy

The Productivity Puzzle

With the progression of the digital economy in the US, figures that historically have been used to measure labor productivity may no longer provide an accurate depiction of productivity growth.
Jim Glassman, Head Economist, Commercial Banking
May 17, 2017

Since the recession, America's economic expansion has undoubtedly slowed. GDP growth since 2007 has averaged just 1.27 percent annually, less than half the 3.43 percent average seen from 1947 to 2007. Much of this slowdown can be attributed to demographics—as the workforce ages and the baby boom generation retires, the total number of hours worked is growing slower than in the past.

But official GDP figures also show that today’s workforce is seeing fewer productivity gains than past generations. From 1947 to 2007, the value of real GDP produced per hour of labor rose at an average rate of 1.75 percent, and that figure has dropped to 0.76 percent since 2007. If productivity had maintained its pre-recession pace, GDP would currently be growing at 2.25 percent annually, and the economy would be at least $1 trillion larger today.

But many economists are asking whether this GDP shortfall is real. Productivity gains are driven by improvements in technology, and the pace of progress has undoubtedly accelerated. Entire sectors of the economy have been transformed by advancements in e-commerce, and Americans are increasingly putting their underutilized resources to work in the gig marketplace. Thus, the Depression-era methodology used to quantify GDP is perhaps missing some of the value added in the digital age.

Accounting for Free Services

Most GDP measurements of economic value can be extrapolated from business receipts, but not all productive activity is billed directly to consumers. For example, produce consumed on farms represents real value that never enters the cash economy. Free checking at banks provides a service that’s not fully reflected on the company’s balance sheets. To determine the economic value of these unbilled goods and services, the Bureau of Economic Analysis uses an imputation formula. Imputations currently account for almost 16 percent of GDP, but that doesn’t capture many of the free services offered today.

Instead, many free digital services are valued similarly to TV and radio—as an advertising product, which in turn is an intermediate input that is eventually included in the price of consumer goods. For the purposes of calculating GDP, the hours that an army of software developers, graphic designers and copywriters spend generating free online content and apps is valuable only as a conduit for ads, not as a source of intrinsic value for consumers.

Investors’ Outlook

If GDP were the only source of information about the economy, the shift toward digital markets and services would largely be invisible. But equities investors see tremendous value where GDP does not. Since 2007, the market value of the technology-heavy NASDAQ equity market index as a ratio to the NYSE’s broader market cap has risen from about 25 percent to nearly 50 percent today.

The valuation of the broader stock market today is comparable to the price-earnings ratios seen during the peaks of past business cycles. If worker productivity growth were truly on a long-term downward trajectory, investors would be pricing in a commensurate decline in anticipated future revenues, leading to lower current stock prices. Instead, the market seems confident that technological advances will continue to improve worker productivity and the potential for future revenue growth is undiminished.

Looking beyond market valuations, we can readily see the value of free digital services in daily life. E-commerce makes consumers more efficient and saves wasted trips, while GPS saves countless hours of wasted driving. It’s hard to imagine that this saved time isn’t making us more efficient workers and consumers. Productivity has certainly changed in the digital age, but it hasn’t necessarily slowed.

View our economic commentary disclaimer.

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