Last week two pieces of news about the American economy were disclosed, with important implications for where the economy is going. On Thursday, the Labor Department reported that during the third quarter of 2009, productivity jumped at the remarkable annual rate of 9¬Ω%. On Friday, the Labor Department also reported that the October unemployment rate in the United States increased to over 10% for the first time in more than 25 years. The productivity numbers were not entirely ignored, but were on the inside pages of the Financial Times, Wall Street Journal, and most other newspapers. By contrast, the unemployment numbers generally received first page coverage at all the major papers, and led to a lot of hand wringing about the economy. Yet while the figures are rather closely related, the productivity numbers in the longer run are the more important ones.
The two numbers are closely related because when productivity increases by a lot, that means much more output is being squeezed out of given inputs of labor and capital. Since during the third quarter the growth in productivity-equal to the growth rate in output minus the growth rate in hours of nonfarm workers- was over 9%, it is arithmetically necessary that hours would decline and unemployment increase since output grew "only" by about 4%. Hours worked did decline by about 5%, and unemployment grew by several percentage points. The very rapid increase in productivity during the third quarter followed a sharp growth in productivity during the second quarter of about 7%. The fast growth in American productivity toward the end of this serious recession is quite unusual because measured productivity often falls during recessions as companies are stuck with excess capacity of their capital. Companies also usually decide to hold on to their best employees, even though they are less than fully occupied with work. American productivity never fell during this recession.i
A rapid growth in productivity is generally a good sign since it means that more is being produced with fewer inputs of labor and capital- it is sort of a "free lunch". However, in a period of reduced employment and rising unemployment, many persons begin to fear that companies are advancing productivity only by laying off employees, and that this process cannot be easily reversed. Throughout history there has been a widespread fear that economies with the most rapid rates of technological progress have trouble generating full employment because jobs are lost as economies become more productive. Such an analysis considers economies to have a fixed number of jobs, so that eliminating some of these jobs reduces the number of workers who can be employed. Recall the Luddite textile workers in early 19th century Britain who attempted to destroy the textile machinery that was being introduced into their industry in an effort to protect their jobs.
Indeed, new technologies and other productivity advances often do destroy many jobs. Computers eliminated the demand for many clerical workers since they were no longer needed to store and process data since computers could do that much more efficiently. Textile machinery destroyed most of the work opportunities for women who made clothes by hand since machines could work much faster and on a much larger scale. Supermarkets helped eliminate the businesses of many small shopkeepers who sold food, and of the men who delivered milk and other foods to homes, since supermarkets sold milk and other goods much more cheaply than did small shops or through home delivery. The Internet continues to eliminate the demand for printers and reporters who work for newspapers and magazines.
Yet over periods more than a quarter of a year or a year, even rapid productivity growth has usually gone hand in hand with growing, not declining, employment. The Internet is providing many jobs, some for reporters who formerly worked at newspapers and magazines. The high tech sectors of Silicon Valley and elsewhere have become major employers of programmers, software engineers, salesmen, and many others. Large growth in employment has also occurred in the biotech field, and the health field more generally, and at other new industries. So while productivity of the global economy increased rapidly during the past century, and also during the past 15 years, world employment also rose rapidly during the past century, and during the more recent period, and world unemployment rates declined rather than increased during both periods prior to this worldwide recession. But the effects of the recession is only a temporary reversal of these longer-term trends.
Nor did the growth in employment come at the expense of earnings since hourly earnings also rose rapidly during the past century along with employment and productivity. This is not at all surprising since higher productivity means that workers and capital tend to produce more output than they did before productivity improved. At the same time that new technologies reduce the demand for worker skills and physical capital made obsolete, the increased productivity of capital raises the supply of other kinds of capital that contributes to a growth in the earnings of workers. The increased productivity of workers also increases their earnings along with their increased employment, although the skill mix of the workers demanded will differ from the mix prior to the growth in productivity.
This is why the rapid growth in American productivity during the past half year is a very good sign for the prospects of the American economy during the next several years. In the very short run, productivity improvements are associated with rising unemployment and reduced employment, but in the somewhat longer run it will raise the demand for workers and earnings. The emphasis on the very short run explains why Friday's unemployment figures received so much more attention than did Thursday's productivity figures, even though the latter are more important for the future prospects of the American economy.