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Low productivity growth continues to confound us

Posted on October 3rd, 2016 by in Chemicals Industry News and Analysis

Productivity construction worker

US productivity growth continues to remain below average, a trend that is reshaping the chemical industry.

Productivity and GDP growth are closely related, and demand for chemicals tends to rise and fall with GDP.

With growth so elusive, many chemical companies are pursuing consolidation-type mergers and acquisitions (M&A), according to analysts and consultants. These deals are justified by the synergies the companies can achieve from their overlapping businesses.

For companies in general, the slowdown in productivity growth has been correlated with a similar slowdown in investments from businesses. The following chart shows private fixed investment, measured in billions of dollars, from the Bureau of Labor Statistics.

Private fixed investment

For the economy has a whole, low productivity growth limits that for interest rates, as illustrated during the current economic expansion. Since the last recession ended in June 2009, the overnight federal funds rate has increased by just a quarter point, to 0.25-0.50%.

Lowering interest rates is among the main monetary tools that the central bank uses to stimulate the economy during a downturn. If interest rates remain low, the Federal Reserve will have less room to lower rates before it has to rely on more unconventional tools.

The magnitude of the slowdown has been significant.

Since 2010, average growth in productivity has been 0.4%/year, said Kevin Swift, chief economist for the American Chemistry Council (ACC). That compares with 2.9%/year in 1948-1973 and 1.4%/year in 1973-1990.

More recently, productivity growth broke 2% during the 1990s and remained strong in the 2000s, reflecting the advancements in communication and information technology, Swift said.

Many causes have been proposed for this decline in productivity growth.

“I think the most important one is that capital available for each employee across the economy has declined,” Swift said. There is a strong correlation between the capital available for each worker and productivity.

“We just haven’t been making the investments in this country, in what’s referred to as capital deepening,” he said.

Other causes include the ageing US population as more members of the baby-boomer generation gets closer to retirement, Swift said. Baby boomers are made up of people born in 1946-1964.

In the book “The Rise and Fall of American Growth”, author Robert Gordon writes that the growth of earlier decades was the result of one-time technology innovations, such as automobiles replacing horses and US homes and businesses gaining access to electricity, clean water and sewage treatment. All of these changed daily life throughout the country, and the benefits of these changes lasted for decades.

Current innovations lack the life-altering effects of these earlier ones, and growth has slowed as a result.

In an article published in Foreign Affairs, Larry Summers diagnosed the problem as secular stagnation, in which savings become out of balance with investments.

Excessive saving lowers demand, which reduces growth and inflation, Summers said. The imbalance between savings and investment also lowers real interest rates.

In a recent speech, Stanley Fischer, vice chair of the Federal Reserve, said the decline could possibly be caused by low business dynamism. During such a period, entrepreneurs start fewer companies and the economy as a whole goes through a slower cycle of job creation and destruction.

An index of US start-up activity kept by the Kauffman Foundation reached its lowest level in at least eight years in 2014. It has since recovered, but the index still has not reached the previous highs of 2009 and 2001.

During her speech last week, Fed Chair Janet Yellen implored policy makers to find ways to increase productivity growth.

The question is how. Some have proposed an expansionary fiscal policy.

Summers wrote that such a policy can reduce national savings, addressing the savings and investment imbalance that causes secular stagnation.

An expansionary fiscal policy can also raise real interest rates and stimulate growth, he said.

In the latest economic policy survey from the National Association for Business Economics (NABE), 43% of the respondents said fiscal policy was too restrictive, while 34% said the current policy was about right.

A majority – 66% – said the main objectives of current fiscal policy should be to adopt structural policies that would stimulate more economic growth in the medium and long term.

Yellen acknowledged that productivity growth is beyond the scope of the central bank, which is charged with setting monetary policy. However, she still shared some general ideas.

These included improving education; spending more on worker training; encouraging capital investment; investing in research and development (R&D); and reducing the burden from regulations without compromising on the problems these rules intend to address.

In Fischer’s earlier speech, he said more effective fiscal and regulatory could boost productivity growth. Like Yellen, he also mentioned improvements in education, private investment and education. Fischer also added public infrastructure.

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All opinions shared in this post are the author’s own.

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