The U.S. could be on the cusp of a productivity boom similar to the one triggered by internet technology in the 1990s. The outlook for the national debt, and much else, depends on it.
Worker productivity is regarded by economists as one of the most important drivers of long-term economic performance. It is essentially just the total output of the economy divided by the number of hours worked, aided by investments in technology and capital. When productivity is booming, it allows the economy to expand faster without triggering inflation. That has positive knock-on effects on all kinds of things, including the fiscal health of the federal government.
Quarterly fluctuations in productivity can be notoriously volatile. The pandemic rendered the data almost impossible to interpret, as both total output and hours worked swung violently. Recently, however, there has been a clear, and highly encouraging, upward trend.
Preliminary estimates from the Bureau of Labor Statistics show that total nonfarm business sector labor productivity increased 2.0% from a year earlier in the third quarter—the fifth straight quarter of growth at or above 2%. That is significant as the average rate of growth for the five years before the pandemic was 1.6%.
Jeff Schulze, head of economic and market strategy at ClearBridge Investments, argues this productivity jump is thanks to some unique features of the postpandemic labor market. People have switched jobs, locations and even industries at a high rate, meaning workers are now better matched to their roles, he said in an interview. In addition, the “extreme labor market tightness” of the postpandemic period led companies to step up investment in time and labor-saving technologies.
“I believe that workers are just much better matched to their jobs today, and what’s happening is now that they are better matched and they’ve been in their roles for a couple years, you’re seeing a boost in productivity that’s going to continue over the next couple of years. And that’s even before all of the investment in artificial intelligence even comes to fruition,” Schulze said.
“When you look on the horizon with all this investment in AI, it’s not hard to get too excited about a productivity boom that will move us up to 2.5% or even 3%,” he added.
To see what a big difference faster productivity could make if it is sustained, consider the Congressional Budget Office’s long-term debt projections. (These are based on estimates of total factor productivity, a somewhat more abstract measure that takes into account the productivity of both labor and capital. But the fundamental drivers and direction are similar to labor-force productivity).
Under its base-case scenario in a May 2024 paper, the CBO sees federal debt held by the public rising from 99% of gross domestic product in 2024 to 116% in 2034. This assumes total factor productivity growth of just 1.1% per year. Raising this estimated productivity growth by half a percentage point would mean the debt-to-GDP ratio reaches a much more manageable 108% of GDP by 2034.
Optimists would argue that the U.S. could do much better. Strategist Ed Yardeni of Yardeni Research is an advocate of a “roaring ’20s” scenario, whereby he sees rapid growth this decade, driven in part by an AI productivity boom. Due to the volatility of productivity data, he prefers to look at a rolling five-year average of labor productivity growth, which hit an annualized pace of 1.9% in the third quarter of 2024, from a low of just 0.6% in the fourth quarter of 2015. Yardeni believes this could reach 3.5% in the second half of this decade.
“That might sound delusional, but past productivity booms in the late ’50s, the ’60s, and the late ’90s, all peaked at 3.5% to 4%,” he said.
These past booms each had their own drivers, according to Yardeni: The interstate highway buildout and rapid suburbanization of the 1950s, mainframe computers and jet engines in the 1960s and, of course, personal computers and the internet in the 1990s.
As these examples make clear, investments by both the public and private sectors can drive productivity gains. Under the Biden administration, the optimistic case for a productivity boom was built partly on fiscal spending by the federal government, which was designed to encourage or “crowd in” private investment on priorities such as domestic chip production, clean energy and electric vehicles, said Jason Draho, head of asset allocation Americas for UBS Global Wealth Management and another “roaring ’20s” advocate. He is less optimistic that lower corporate taxes under the second Trump administration would have as positive an impact on investment, saying much of the previous round of business tax cuts was spent on share buybacks and dividends instead.
But others see ways that tax policy can keep encouraging investment in productivity-enhancing technology. ClearBridge’s Schulze points to the full expensing of investments in equipment, a provision of the 2017 tax cuts that began being phased out in 2023 but could be renewed as part of a new tax package.
For his part, Yardeni said he began talking about a “roaring 20s” scenario in 2019, and it was never based on assumptions about policy. “What I’ve learned over the years is to respect how well the economy does despite Washington,” he said.
For those hoping the U.S. economy can keep up its growth and resilience no matter what happens in the nation’s capital, productivity growth holds the key. Quarterly productivity readings, volatile as they may be, will be one of the most important indicators to watch in the years ahead.
MSN
