Capitalism and Western Civilization: Productivity

William H. Young

“There’s been a lot of bad economic news lately, but we may be overlooking the most disturbing development of all: our economic productivity has been weakening” warned George Mason economist Tyler Cowen in “The Sad Statistic That Trumps the Others” in The New York Times on August 20, 2011. Cowen is the author of The Great Stagnation (2011). On February 2, 2012, the U. S. Bureau of Labor Statistics (BLS) confirmed that average productivity increased only 0.7 percent in 2011, down from 4.1 percent in 2010 and 2.3 percent in 2009, near the level of 0.6 percent in 2008. Why is that of concern?

Productivity, what some call efficiency, is a mundane but fundamental economic concept that is at the heart of capitalism. In The Wealth of Nations (1776), Adam Smith used the example of the “trifling manufacture” of a pin; labor specialization and capital investment in machinery permit man’s productivity and wealth to be vastly increased.

Productivity is the principal driving force for positive economic growth (and attendant tax revenue) and an improving standard of living. Economic growth is of Gross Domestic Product (GDP), the total output value of all the final goods and services produced in the nation’s formal economy. Productivity is measured in output per hour worked in the economy’s nonfarm business sector. The economy can grow without inflation only as fast as the growth of the labor force plus the rate of productivity improvement.

All the economic and social gains of the twentieth century occurred because of gains in productivity, explained the late management guru Peter F. Drucker in “The Rise of the Knowledge Society” (The Wilson Quarterly, Spring 1993). Over the twentieth century, there was a fifty-fold increase in output per worker. In the 100 years before 1973, national productivity increased at an average annual rate of 2.4 percent, report Bob Davis and David Wessel in Prosperity (1998). From 1950 to 1973, productivity grew at a rate of 2.7 percent (and GDP at over 4 percent), creating the expectation of rapidly growing prosperity for all. But between 1973 and 1979, the rate of productivity growth dropped to 1.1 percent, according to the BLS. Why was that?

Washington Post economics columnist Robert J. Samuelson explains in The Great Inflation and Its Aftermath (2008) that starting under President Kennedy in 1960, amplified by the Great Society programs of 1964–1965, and continuing with the support of all following administrations until 1980, the flawed ideas of academic social science, accepted by political and business leaders, would lead to what Samuelson calls “the great inflation.” Academic economists (Heller, Samuelson, Tobin, Solow) argued that the economy could be managed and kept perpetually near “full employment” by stimulative government spending—“without the need to rely on the ‘animal spirits’ of businessmen,” adds Johns Hopkins’ economics professor John Quiggin in “Surviving the Capitalist Tsunami” (The Chronicle Review, January 20, 2012).  The academics would outdo their hero Keynes with advanced Keynesianism—the New Economics. To mark the moment, Time put Keynes on its cover at the end of 1965.

A growing inflation was seen as an acceptable byproduct of such policy. “The result of this mind-set was that the same mistakes were repeated for fifteen years,” adduces Samuelson; “ideas ruled the roost, and the ruling ideas were wrong. Because they had created public… expectations that couldn’t be met, the effort to do so ultimately made matters worse.”

A wage-price spiral set in, driven in part by large union wage and benefit increases negotiated with industrial corporations, who then raised prices, leading to greater wage demands. “In some industries—such as steel, autos, and trucking—wage premiums, or the excess of wages in a given industry over the national average, vaulted from the 30‒40 percent range at the beginning of the 1970s to over 70 percent by the end of the decade,” revealed an analysis, “U. S. Mergers Are Helping Productivity,” in Challenge (May/June 1987). From 1960 to 1980, annual inflation increased from a negligible 1.4 percent to almost 15 percent. In all of American history, there had been no comparable precedent. Interest rates rose to over 20 percent.

In the 1970s, General Motors provided the UAW the right to retire after 30 years with full pension and benefits, in a contract filled with work rules as thick as a big-city phone book.  “Productivity growth slipped badly” during the 1970s, found the Challenge analysis, because “ever rising product prices protected inefficient production practices.” Moreover, the wage gains “failed to reflect the slump in output per hour.” High inflation and low productivity began the stagnation in real (inflation-adjusted) wages and living standards.

Following his 1980 election victory, Ronald Reagan brought new ideas about government and economics to the presidency. As important, Paul Volcker, Chairman of the Federal Reserve System, raised the prime interest rate to 21 percent, inducing the savage recession of 1981–1982 in which unemployment peaked at 10.8 percent. Disinflation was dramatic. By 1982, annual inflation was reduced to 3.7 percent. Reagan rejected advanced Keynesianism and the mixed economy. He applied the different economic ideas of Friedrich Hayek and Milton Friedman aimed at increasing capital investment, productivity, and economic growth—and the private sector jobs they produce.

Productivity improved, according to the BLS, but only slightly and slowly, remaining below 1.5 percent until the mid-1990s, when the effects of corporate restructurings and computer technology began to emerge. Thus, over that period, wages and the standard of living continued to stagnate even though average annual GDP growth was about 3 percent. Between 1996 and 2000, during the Internet (dot-com) bubble, productivity improved to 2.8 percent, GDP grew at a rate of about 4 percent, and wages increased—like the halcyon days of the 1950s. But the productivity growth rate fell again after business investment in high-tech equipment plummeted in late 2000. Between 2001 and 2010, annual productivity growth averaged nearly 2.5 percent, but annual GDP growth was only about 2 percent.

Cowen considers that productivity may (once again, ironically) be overstated by the higher wages rather than efficiency of higher-skilled knowledge workers who have displaced lower-skilled, lower-wage workers. Lack of innovation, government regulation and policies, and the ever-rising proportion of less-productive government consumption, including health care and education, could also be factors. 

Harvard economists Claudia Goldin and Lawrence F. Katz warned in The Race Between Education and Technology (2008) that since the 1970s, American educational attainment no longer produces enough workers with the skills needed to keep up with technological advance—impeding growth and competitiveness and increasing inequality. In “How U. S. Lost Out on iPhone Work” (The New York Times, January 21, 2012), Charles Duhigg and Keith Bradsher report that Apple’s executives invest overseas because “the flexibility, diligence, and industrial skills of foreign workers have so outpaced their American counterparts that ‘Made in the USA.’ is no longer a viable option for most Apple products.”

In “The Age of Social Transformation” (The Atlantic, November 1994), Drucker defined the economic challenge of the Knowledge Age as increasing the productivity of knowledge workers to permit both individuals and corporations to compete and prosper in a global economy. He saw the social challenge of the Knowledge Age as increasing the productivity of non-knowledge service workers—to enable them to earn decent incomes and have dignity in a competitive global economy.

Our colleges and universities should respond to Drucker’s challenge; our future standard of living depends, in part, on such action. And the above kind of historical national economic perspective should be part of the liberal education that NAS seeks to have the academy provide.

Next week’s article will examine the restructuring of Corporate America that began through “financial capitalism” in the 1980s to regain its competitive position.
This is one of a series of occasional articles applying the lessons of Western civilization to contemporary issues relevant to the academy.

The Honorable William H. Young was appointed by President George H. W. Bush to be Assistant Secretary for Nuclear Energy and served in that position from November 1989 to January 1993. He is the author of Ordering America: Fulfilling the Ideals of Western Civilization (2010) and Centering America: Resurrecting the Local Progressive Ideal (2002).

Image: Wikimedia Commons, Public Domain

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