Comment on productivity trends

In: Uncategorized

11 Feb 2008

The latest Fund Strategy has a comment by me on the debate about productivity trends in America.

It seems a world away but the late 1990s discussion of the “new economy” is worth revisiting in the light of recent data. Looking at trends in productivity growth helps discern the direction in which the American economy, and possibly the markets, are likely to be heading.

Back in the second half of the 1990s there was an obsession with rising productivity growth. The argument was that the diffusion of new technology, such as the personal computer and the world wide web, was making the American economy more dynamic. The rise of numerous dotcom companies seemed to confirm this trend.

In a self-serving way many financial institutions promoted the idea of the “new stockmarket” to complement that of the new economy. Many fund managers endorsed the argument that rising productivity growth meant market valuations could be revised permanently upwards. The theory seemed to explain the stockmarket surge of the late 1990s.

Then reality intervened with decisive brutality. In early 2000 equities started to fall and a three-year bear market followed. It seemed that the golden new era, with ever rising markets, was a mirage after all.

Given the attention paid to the productivity figures a few years ago, it is perhaps surprising that they are hardly discussed today. Maybe it is too painful a memory. But the latest statistics are revealing.

Superficially, the figures appear reasonable. According to America’s Bureau of Labor Statistics, productivity grew at an annual rate of 1.8% in the fourth quarter of 2007. But Professor Robert Gordon of Chicago’s Northwestern university, a renowned expert on productivity, has calculated that the long-term trend rate for productivity growth has fallen back to 1995 levels. It appears that if there was a spurt in productivity growth, it was relatively short-lived.

Several lessons can be learnt from this. First, it is a mistake to draw sweeping conclusions from short-term trends. A few years of above-trend productivity growth do not make a new economy.

Second, the American economy is not as dynamic as many have claimed in recent years. Productivity growth is an important indicator of underlying economic strength.

Finally, beware of theories that link apparently positive economic developments to the stockmarket. Self-serving ideas normally come unstuck sooner or later.