FRBSF Economic Letter
2004-18; July 16, 2004
The Productivity and Jobs Connection: The Long and the Short
Run of It
Ask any economist and he or she
will tell you that faster productivity growth leads to higher real
wages and improved living standards. So, from those perspectives,
the recent evidence of strong productivity growth in the U.S. is
good news.
 Figure 1 shows, by decade, the relationship between
productivity growth and the growth rate of real labor compensation
per hour. The decades of slow productivity growth have been decades
of slow growth in real wages; decades of faster productivity
growth have been decades of faster growth in real wages.
Yet a quite different
picture of productivity growth dominates the news. Numerous newspaper
articles blame strong productivity
growth for a “jobless recovery,” as economic output
grows yet employment does not. Faster productivity growth, according
to this view, allows firms to increase production without increasing
employment. While recent employment figures suggest that job growth
may finally be accelerating, the slow growth in new jobs during
the past two years has raised doubts about the benefits of faster
productivity growth.
These two views of productivity growth seem
dramatically inconsistent. If higher productivity allows firms
to shed workers, how can it
raise wages and living standards? If productivity does lead to
improved wages and living standards, why do so many feel the
recent productivity growth has left workers behind?
To answer these
questions, and to understand how both views contain part of
the truth about productivity, we need to distinguish
both between a microeconomic and a macroeconomic perspective
on productivity
and between the short-run and long-run effects of changes
in productivity. This Letter discusses these different
perspectives on the productivity-jobs
connection. The macro versus micro perspective
Variations in productivity growth have both microeconomic and
macroeconomic effects. Microeconomics investigates the structure
of individual industries and markets, and the behavior of individual
firms and consumers. From a micro perspective, productivity growth
and new technological innovations are constantly leading to structural
changes in the economy, causing one industry to expand in terms
of both production and employment, while other industries shrink.
The rapid growth of the high-tech industry during the 1990s and
the effects of research in biochemistry on the pharmaceutical industry
are just two recent examples of such changes. At the same time,
technological changes can cause other industries to contract. The
introduction of word processors and personal computers had a devastating
effect on firms producing electric typewriters, for example. These
micro factors produce an enormous amount of change each year in
the American labor market. As a consequence, small changes in overall
employment can mask the quite large numbers of jobs that disappear
and are created every year. For example, according to Pivetz et
al. (2001), in the fourth quarter of 1999, the net gain in employment
of 1 million was the result of the loss of just over 8 million
jobs and the creation of over 9 million new jobs.
Similar phenomena
can be observed when looking across industries. For example,
while the share of manufacturing in total U.S. GDP
has remained roughly constant over the past 50 years, rising
productivity in manufacturing means that this level of production
can be achieved
with fewer and fewer workers. Thus, employment in manufacturing
as a share of total employment has declined over the past 50
years. In contrast, employment and output in areas such as the
computer
industry, areas of economic activity that did not exist 50 years
ago, have grown rapidly. These shifts in the economy cause jobs
to disappear in some sectors while jobs are created in others.
Rather than focusing on specific industries or sectors of the
economy, macroeconomics focuses on the overall behavior of the
economy (e.g.,
overall levels of income, production, employment, inflation).
Thus, while important issues of public policy are involved in
deciding
how best to assist workers displaced by these changes, the question
from the macroeconomic perspective is whether faster productivity
growth does more than simply shift the types of jobs available
in the economy: Does it alter the total level of employment and
wages? And to address this issue, it is useful to distinguish
between the short run and the long run.
The short run
If firms see the demand for their products rise, they respond
by expanding production. And if labor productivity is unchanged,
then typically they need to hire more workers to do this. But if
labor productivity is increasing, then it has the potential to
reduce employment growth, because the firm will be able to satisfy
demand using fewer workers. Likewise, if overall demand in the
economy has not expanded, then an increase in labor productivity
could lead to a fall in employment in the short run. In this case,
faster productivity growth might lead to an increase in job loss
without a corresponding increase in job creation in new and expanding
industries.
The long run
Economics teaches us that, in the long run, income and employment
depend not on demand but instead on supply factors—the economy’s
stock of capital, its labor force (measured in terms of both the
quantity of labor as well as its quality as reflected, for example,
in educational levels), and its technology. At the macro level,
the level of income that results when the economy’s factors
of production are fully and efficiently utilized is often called
potential GDP.
While the short-run perspective emphasizes the impact
of productivity on the number of workers needed to produce
a given level of output,
the long-run perspective emphasizes that an increase in labor
productivity increases potential GDP. It does so directly by
allowing more output
to be produced with the same level of employment, but it also
increases employment because it decreases the cost of labor to
firms and
promotes the creation of new industries. For firms, the relevant
cost of labor is not measured simply by the wages and benefits
paid to the workers. Rather, it is measured by the costs of
these wages and benefits relative to the output the workers are
able
to produce. Just as a rise in wages increases labor costs if
worker productivity remains constant, a rise in labor productivity
lowers
the cost of labor at a given level of wages and benefits. And
if higher productivity makes labor less costly, firms will find
it
profitable to expand employment. As the new technological innovations
that boost productivity occur, new industries arise, along
with the creation of new jobs. The increased demand for labor will
tend to boost wages, as firms compete to hire additional workers,
and
raise total employment. With higher employment and productivity,
potential GDP increases. Getting from here to there
The short-run and long-run effects of productivity growth may
appear contradictory. How can faster productivity growth depress
job creation in the short-run but increase wages and employment
in the long-run? In the short-run, productivity growth increases
the economy’s potential GDP, but if actual GDP does not rise
in tandem, actual GDP will fall short of potential, a situation
described as a “negative output gap.” Expanding investment
and consumption spending serve to close the negative output gap.
Often, taking advantage of new technological innovations requires
that firms increase investment spending to purchase new equipment,
and lower labor costs boost profits and the stock market. This
increase in overall wealth contributes to a rise in consumption
spending. Critically, wages and prices also adjust to restore equilibrium
in the economy. These adjustments reduce the output gap until actual
GDP rises to match the new level of potential GDP.
Monetary policy
plays an important role in this adjustment process. The Fed, like
many other central banks, is concerned with keeping
inflation low and stable and with promoting macroeconomic stability.
Promoting macroeconomic stability normally means the Fed focuses
on the output gap as well as on inflation. If inflation is under
control, a negative output gap is a signal that policy should be
more expansionary, thereby speeding the elimination of the output
gap and returning actual GDP to potential GDP. For example, the
Fed’s policy of maintaining its policy interest rate at low
levels for the past three years was designed to help eliminate
any negative output gap. Of course, Fed policy actions affect the
economy with a lag, so it is not today’s output gap that
must be the focus of policy, but rather the outlook for the gap
in the future.
The evidence
Several economists have tried to estimate the short-run and long-run
impacts of productivity shocks on employment. In one of the first
papers to investigate this issue, Galí (1999) found that
an increase in productivity growth initially reduced overall employment
in the economy. The effects on employment, however, were found
to be temporary. Thus, his results were consistent with the short-run
and long-run effects discussed above.
While the negative impact
of faster productivity growth on employment eventually disappears,
leaving only the positive impact on incomes,
the period of adjustment may be slow and drawn out. Galí,
for example, estimated that it would take about seven quarters
for total hours worked to return to their initial level after a
productivity innovation.
While most subsequent research has confirmed
Galí’s
basic conclusions, some researchers have disputed his findings.
For example, Christiano et al. (2003) argue that productivity raises
total hours worked even in the short-run. The different findings
are attributed to two sources. First, different methods for estimating
productivity shocks seem to account for some of the differences.
Second, the results are sensitive to the researchers’ assumptions
about the long-run behavior of hours worked and whether one assumes
hours per capita have fluctuated around a constant level during
the past 50 years. While this may seem to be purely a technical
statistical issue, it does seem to matter for the empirical results.
 In any event, there is little debate among economists about the
long-run effect of productivity on employment. And this effect
is evident in some simple measures of the relationship among
productivity, wages, and unemployment. In the long run, faster
productivity growth
should translate into an increase in the overall demand for labor
in the economy. This, in turn, will lead real wages to rise,
just as an increase in the demand for a typical good or service
acts
to bid its price up. Figure 1 showed that this positive relationship
between productivity growth and real wage growth holds across
decades.
Figure
2 shows the relationship by decades between productivity
growth and the unemployment rate. Consistent with the longer-run
perspective, periods of faster productivity growth are not
associated with higher average unemployment rates.
Conclusions
Innovation and technological change bring benefits to the economy
and contribute to rising standards of living. But such changes
inevitably require that resources, including labor resources, be
shifted from shrinking industries to expanding industries. This
process can be costly and painful for the workers whose skills
are no longer in demand. A macroeconomic perspective helps to highlight
the contrasting short-run and long-run impacts of productivity
growth on employment. While faster productivity growth may reduce
employment in the short run, it promotes employment and higher
wages in the long run.
Carl E. Walsh
Professor of Economics, UC Santa Cruz,
and Visiting Scholar, FRBSF
References
URLs accessed July 2004.
Christiano, L.J., M. Eichenbaum, and
R. Vigfusson. 2003. “The
Response of Hours to a Technology Shock: Evidence Based on Direct
Measures of Technology.” Mimeo. Federal Reserve Board of
Governors. http://www.federalreserve.gov/pubs/ifdp/2003/790/ifdp790.pdf Galí,
J. 1999. “Technology, Employment, and the Business
Cycle: Do Technology Shocks Explain Aggregate Fluctuations?” American
Economic Review 89(1) pp. 249–271.
Pivetz, T.R., M.A. Searson,
and J.R. Spletzer. 2001. “Measuring
Job and Establishment Flows with BLS Longitudinal Microdata.” Monthly
Labor Review (April) pp. 13–20. http://www.bls.gov/opub/mlr/2001/04/art2full.pdf
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