Investors often pay too little attention to longer-term developments – such as the slowdown in labour productivity growth.
What’s the real story?
In the US, output per worker-hour in the non-farm business sector has grown just 1.3% per year in the last seven years. That compares to growth of 2.2% per year in the previous 20 years. In the UK, the slowdown has been more marked. Having grown by 2.1% per year in the 20 years to 2008, GDP per worker-hour has actually fallen since then. The productivity slowdown in the euro area has been less sharp, but only because it was so weak before 2008.
Why investors should care
This matters enormously because low productivity growth often means low returns on both cash and shares. Productivity slowdowns in the early 1920s and 1970s saw both share prices fall and lower real returns on cash while accelerations in productivity in the 1960s and 1990s saw good returns on both shares and cash.
The last few years fit this pattern. Returns on cash around the Western world have been around zero, and shares haven’t done well either: since the end of 2007 the S&P 500 has risen only 2.9% per year after inflation. There’s a simple reason for this. Productivity, ultimately, governs how fast the economy can grow.
But job growth is up
Of course, flat productivity can co-exist with decent growth for a while because employment can increase. But this cannot continue for long without either pushing up inflation or squeezing profit margins as labour costs rise. This in turn means low returns on cash because low growth causes central banks to keep interest rates low.
And it means poor returns on equities because low GDP growth means low earnings growth – especially if firms have to spend more on labour. Weak productivity is therefore a big problem for savers.
A real head-scratcher
Why is productivity so weak? Here, economists are scratching their heads. The fact the productivity slowdown coincided with the financial crisis suggests there might be a link between the two. One theory is that because banks have been reluctant to lend since the crisis, new and efficient firms have been unable to expand. This has killed off one source of productivity growth – the closure of old inefficient firms and their replacement with better ones.
The evidence, however, is not wholly consistent with this. In the UK, economists at the National Institute of Economic and Social Research have found that most of the productivity slowdown has come within existing firms. And in the US, job creation rates have been reasonably high since the crisis.
When zombies attack
These facts are inconsistent with the idea that productivity has slowed because of less growth of new firms. They are, however, compatible with the idea that “zombie firms” – chronically inefficient ones – have not been killed off in this crisis, perhaps because ultra-low interest rates and banks’ reluctance to close them down have caused them to linger on.
Firms may not invest
A more promising explanation is that firms have for years been reluctant to invest. As a result, workers are working with older, out-dated equipment and so are less efficient. Research from market analyst Gartner also suggests companies have indeed been spending less on tech.
One reason for low capital spending might be that falling real wages has reduced the need to substitute capital for labour. Another is that a slower pace of technical progress means there’s less scope to increase efficiency by buying new equipment: the robot revolution – for now at least – is more discussed than observed.
This too shall pass – or will it?
What we do not know is whether these factors are temporary or not. Techno-optimists such as MIT’s Erik Brynjolfsson and some economists at the Bank of England believe they are temporary. Others such as Northwestern University’s Robert Gordon fear they might be more permanent. Savers should hope the former are right.
You might think that economists’ talk of secular stagnation is mere academic theory. It’s not. By “secular stagnation”, we mean the combination of slower productivity growth, weak investment and slower technical change, all of which have combined to give savers and investors low returns. In this sense, apparently academic debates among economists matter much more for savers than the daily noise that passes for news.