A version of this post originally appeared on Quora
Economic theory suggests that total factor productivity (TFP) and labor input are the two key drivers of economic growth.
For background, TFP is a broad measure of the productivity of the inputs used in a business sector. Labor input refers to the hours worked adjusted for the influence of education and experience on worker productivity.
In my recent research with Hornstein, Sarte, and Watson (2019), we estimate that trend GDP growth fell about 2.3 percentage points since 1950 to around 1.7 percent. This trend GDP growth is the growth rate once we strip out short-term, transitory changes in TFP and labor input and instead focus on long-term, persistent forces.
Our research focuses on which sectors contributed significantly to this decline. Particularly, how did spillovers between sectors amplify the effect of sectoral changes? Our analysis focuses on the long-term rather than temporary changes, looking at how common and sector-specific trends affect GDP growth.
Changes in growth in TFP and labor input can be broken down into four components:
- a common trend across sectors
- sector-specific trends
- a common temporary change across sectors
- sector-specific temporary changes
Next, we isolated sector-specific trends that play the largest role in explaining slowing GDP growth.
Among the common trends across sectors, overall trend labor growth fell from 2 percent to about ½ percent since 1950. Similarly, overall trend TFP growth across sectors declined around ½ percentage point during the same time span.
Given these declines in trend labor and TFP, to what extent does slower growth matter for declining trend GDP growth?
To dig into this further, we account for production linkages between sectors. In other words, slower growth in one sector can spill over to lower growth in other sectors. For example, the construction sector is relatively important to other sectors because it produces buildings and structures that make production possible. So, if the construction sector slows, it can limit a manufacturer’s plans to expand, and therefore indirectly slow growth in the manufacturing sector.
Our estimates show that the following three sectors with slowing growth and linkages to other sectors account for about 1.4 percentage points, or 60 percent, of the decline in trend GDP growth:
- nondurable goods
- professional and business services
Construction played the largest role in the slowdown. That sector’s TFP growth slowed over the period we study, and that sector also has relatively high importance as a supplier of investment goods. The implication? The construction sector contributed about ¾ percentage point, or 30 percent, of the decline.
Andrew Foerster is a research advisor at the Federal Reserve Bank of San Francisco.
Foerster, Andrew, Andreas Hornstein, Pierre-Daniel Sarte, and Mark Watson. 2019. “How Have Changing Sectoral Trends Affected GDP Growth?” FRBSF Economic Letter 2019-18 (July 8).
Foerster, Andrew, Andreas Hornstein, Pierre-Daniel Sarte, and Mark Watson. 2019. “Aggregate Implications of Changing Sectoral Trends.” Federal Reserve Bank of San Francisco Working Paper 2019-16.
The views expressed here do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System.