⤴↗📈 Has the Great Upshift arrived?

Another strong quarter for US productivity growth is far from conclusive. But it's also a super encouraging sign. Let's enjoy it.

Feb 01, 2024

Quote of the Issue

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The Conservative Futurist: How To Create the Sci-Fi World We Were Promised

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The Essay

⤴↗📈 Has the Great Upshift arrived?

Americans experienced a totally unexpected deceleration in technological progress and economic growth starting in 1973, what I call the Great Downshift. … While the 1930s Great Depression is the most famous event in modern economic history—the deep downturn plunged the world into economic and political chaos while planting the seeds for the next global war—the Great Downshift certainly rivals it in importance. … Although productivity and economic growth didn’t come to a total stop, the substantially slower pace—both in absolute terms and compared to Up Wing 1.0 expectations—has led others to call the post-1973 period the Long Stagnation or Great Stagnation. - The Conservative Futurist: How To Create the Sci-Fi World We Were Promised

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Let’s begin with a caveat: Yes, labor productivity data are notoriously bouncy. They’re a derivative of other economic numbers, themselves subject to revision, and especially jumpy during times of economic turbulence. Caution is warranted.

But, but, but … the US Bureau of Labor Statistics today released the 2023 fourth-quarter result for nonfarm business sector productivity, and it was pretty good — again. Productivity rose by a better-than-expected 3.2 percent during the final quarter of last year and was up by 2.7 percent on a year-ago basis. Even better, productivity growth has now increased at a rapid pace for three straight quarters, including 4.9 percent in Q3 and 3.6 percent in Q2.

Given both the advances in artificial intelligence/machine learning, which emerged before ChatGPT in 2022, and similarly strong productivity numbers in 2019, the last pre-pandemic year, it’s certainly worth contemplating whether we’re seeing the start of a (hopefully sustained) period of elevated productivity growth. Which would be totally awesome for several reasons.

For starters — and this is the thing that’s top of mind for most people, including Wall Street — strong productivity growth has contributed to a “Goldilocks” scenario where inflation has declined even as the economy has continued to grow. As RSM economist Joseph Brusuelas explained in his morning note today:

[Rising productivity] helped create the conditions in which the economy could grow faster even at full employment while inflation growth eased at the same time. One might even state that is what is causing the soft landing of the economy following the inflation and interest rate shocks that started in 2021. Rising productivity is a classic economic win-win that benefits each participant. And of course, rising productivity helps the Federal Reserve as it seeks to fulfill its dual mandate of achieving price stability and maximum sustainable employment.

In other words, productivity growth is the friend of inflation-fighting central banks everywhere, and the Federal Reserve is hardly an exception. Here’s an interesting exchange at Fed Chair Jay Powell’s Federal Open Market Committee news conference yesterday:

Q: Hi. Victoria Guida with Politico. Could you talk a little bit more about productivity growth? You know, you’ve mentioned multiple times about, you know, the level of wage growth that’s consistent with 2 percent inflation. We’ve obviously seen—you know, you were talking about ECI this morning, in which it’s cooled a little bit it’s still sort of above what you wanted to see. Growth has been very strong. How much of those numbers do you attribute to productivity? And do you see that productivity as sort of just temporary because of the factors—the labor and supply chain factors you were talking about? Or do you think that productivity growth will fade over time?
MR. POWELL: So this is a really interesting question. And I think—my own view is, I think if you look back to the pandemic, you saw a spike in productivity as workers were laid off and activity didn’t decline as fast. And then you saw a deep trough of productivity. And then over the last—you saw high productivity last year, in ’23. I think we’re basically in the throes of getting through the pandemic economy. And the question will be, what is it that has changed? You know, productivity tends to be based on, you know, fundamental aspects of our economy.
Is there—is there a case—will it be the case that we come out of this more productive, more—on a sustained basis? And I don’t know. I don’t know. What would it take? It would take—you know, people talk about AI, but I would—my guess is that we may shake out and be back where we were because I don’t — I’m not sure I see—work from home doesn’t seem like it’s a big productivity increaser. AI—artificial intelligence, generative—may be, but probably not in the short run; probably maybe in the longer run. So I’m not—I’m not seeing why it would, but you know, right—you know, right now I would say that productivity is kind of what falls out of the broader forces that are driving people in and out of the labor force, and activity returning, and supply chains getting fixed.

Like Powell, Brusuelas isn’t crediting remote work or AI for the productivity gains.

The economist notes highlights several growthy supply-side factors:

Over the past six months, strong investment spending-fueled productivity growth, with outlays on structures surging at an eight percent quarterly pace, intellectual property rising 5.5 percent, and equipment increasing 2.8 percent.
Additional labor supply came as higher pay attracted discouraged workers back to work. Full employment let workers get better jobs and training, increasing output per hour.
New laws like the CHIPS and Science Act, Infrastructure Investment and Jobs Act, and Inflation Reduction Act expanded manufacturing capacity, energy alternatives, and legal immigration.
With high inflation, borrowing costs and hiring challenges, businesses had to become more efficient, making productivity-enhancing investments in response to economic conditions.

Yet Powell’s comments suggest the big question moving forward: Is the current productivity upturn still pandemic-related, or has something happened to cause a sustained upshift that would take it beyond the 1.5 percent annual pace we’ve seen overall since 2007? Remember, given the pace of labor force growth, that productivity pace means the US economy’s non-inflationary growth potential is only two percent. (The Congressional Budget Office (CBO), for instance, is only looking for 1.3 percent productivity growth over the next 30 years, leading it to a 1.6 percent GDP forecast.)

But if the American economy could do better than that CBO productivity forecast, it would not only mean a bigger economy than otherwise — not an insignificant asset when you have a global economic and military competitor like China — but a faster-rising standard of living for the American people. So I hope Powell is wrong, and if we’re not already seeing an AI impact, one is just around the corner. And what is the case that he might be wrong?

Conveniently, Erik Brynjolfsson, perhaps the world’s leading economist when it comes to analyzing the digital economy, just did a long interview with the Financial Times. And he’s pretty bullish on the productivity impact:

I’m optimistic the technologies will affect a large number of tasks. A big percentage of the work that is done in a modern economy is amenable to being augmented by LLMs and generative AI. The effects on those tasks have been significant — double-digit productivity gains within just a few months in some of the cases I’ve studied. Multiply the large percentage of affected tasks by sizeable productivity gains for each one and you get a big total economic impact. I’m betting that productivity growth is maybe significantly higher in the 2020s than the Congressional Budget Office is projecting. They projected 1.4 per cent average per year. I think it could be twice that — closer to 3 per cent — maybe more.

Brynjolfssson went on to compare AI’s potential impact to that of past general-purpose technologies like electricity. He says AI could be even more transformational: it’s advance is rapid, pervasive, and spawning complementary innovations. And whereas past technologies like electricity took decades to affect growth, Brynjolfsson expects the economic effects of generative AI to happen much faster. Significant productivity gains are happening in months in many cases. He also notes that gains so far have benefited lower-skilled workers more on average. Makes sense: AI tools are relatively easy to use compared to past technologies, allowing faster deployment and benefits. And while it’s still early, investment and activity around developing and deploying AI tools is ramping up quickly at technology companies. On that all-important investment point:

We are still in the early stages of the gen AI revolution. While developers like OpenAI and Google are making significant investments in computing power to build ever-larger models, most users are just in the exploration and early deployment stages. Of course, many of them will be relying on cloud services so the investments will show up there. As we can see from Nvidia’s sales and market cap, demand is strong and is likely to grow significantly for computing power. Likewise, the leading companies are now developing aggressive game plans for investments in software and training so they can implement gen AI solutions.

If Brynjolfsson — and the other techno-optimists I frequently mention in this newsletter — are correct, the New Roaring ‘20s still await. But maybe more than that. Maybe a Great Upshift in long-term technological progress, productivity growth, and economic dynamism that will help create a tomorrow far more prosperous and opportunity-filled than what most people are expecting right now. The recent evidence provides hope, but more is needed. I will be watching closely.