Over the past decade, productivity growth has markedly declined. This slowing is significant – it’s global and it started before the global financial crisis threw the international economy off course.
Moreover, this slowdown has occurred at a time when the rapid pace of innovation and technological change was generally expected to turbo-charge productivity.
And there’s more to come. Productivity seems likely to decline in the US in 2016, while growth is tepid in other affluent countries.
Productivity measures the output of goods and services relative to the input that goes into their production. The often-quoted observation of Princeton University professor Paul Krugman is spot on:
“Productivity isn’t everything, but in the long-run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.”
Krugman could well have added that productivity growth is also the main source of returns for investors over the medium term and longer, and a sustained fall in productivity growth means a reduction in those returns.
In the short term, however, it can help reduce unemployment. The US, Germany, Australia and New Zealand are creating more jobs from small increases in GDP than they would have had productivity growth been stronger.
Productivity is difficult to measure
Alas, productivity is hard to measure: the numbers jump around from quarter to quarter, and are subject to wide revision. Let’s put those problems aside for now and follow the suggestion of Jeffrey Kleintop, chief global strategist with US broking group Charles Schwab:
“The focus for investors shouldn’t be on the exact number [for productivity growth], but instead on the general trend that productivity is lower now than in the past.”
Kleintop outlines five strategies to help investors cope with the diverse effects of the productivity slowdown.
- The return of inflation. Low growth in productivity, if sustained, will probably result in output increasing at a slower rate than demand – and thereby contribute to the return of inflation. Share investors would need to focus on companies that can best pass on higher costs – and, I’d add, those with money in interest-bearing investments would likely be attracted to floating-rate debt and inflation-linked bonds.
- Shortages of tax revenue. With tax receipts likely to grow much slower than outlays on welfare and health, governments will face additional budget strains and deepening worries over high debt levels. Over time, interest rates would push higher.
- Emerging market growth. In general, emerging market economies will have fewer problems than developed economies in adjusting to the global productivity slowdown, as they have greater scope to boost productivity by adopting innovations already in place in developed-market economies.
- Profit margin pressure. Low productivity growth generally means faster growth in labour costs, which can squeeze margins. Share investors may need to favour companies “that can more easily substitute technology for labour or are less exposed to labour costs as a percentage of total costs”.
- Less creative destruction. The US could see fewer business start-ups as the result of the slowing in innovation and in adoption of new technologies.
There’s a view widely held by those involved in international technology hubs that the slowdown of growth in measured productivity mainly reflects the difficulties in calculating productivity – particularly in service industries, that have been keen adopters of new technologies. However, as New York University’s Nouriel Roubini notes:
“if this were true, one could argue that the mis-measure of productivity growth is more severe today than in past decades of technological innovation.”
Slow productivity growth seems likely to be prolonged by the low levels of business investment most economies have experienced since the GFC. The risks, too, are that productivity growth is further constrained by the populist backlash against policies such as globalisation and market-based reforms. These policies offer the best prospects for raising the rate of productivity growth.
Investors, among others, have a lot at stake regarding how the global productivity crisis is resolved. If near-zero rates of productivity growth persist, long-term average returns on investments will disappoint, inflation will return, government finances will be even harder to balance, and cycles in the economy and investment markets will widen.
Don Stammer is a former director of investment strategy with Deutsche Bank Australia. He now writes a fortnightly column on investments for The Australian.