Labor Productivity

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The following is excerpted from a speech given by Federal Reserve Chairman Ben S. Bernanke to the Greater Omaha Chamber of Commerce in Omaha, Nebraska on February 6, 2007. In it he discusses income inequality in the U.S. and how labor productivity gains have benefited higher educated workers greater than those with less technical skills:

“What are the underlying sources of these long-term trends in wages, incomes, and other measures of economic well-being? Economists have established that, over longer periods, increases in average living standards are closely linked to the growth rate of productivity—the quantity of goods and services that can be produced per worker or per hour of work. Since 1947, hourly labor productivity in the U.S. nonfarm business sector has increased a robust 2-1/4 percent per year, and productivity growth has been close to or above that figure in most of the past ten years. This sustained productivity growth has resulted in large and broad-based improvements in the standard of living. When discussing inequality, we should not lose sight of the fact that the great majority of Americans today enjoy a level of material abundance—including the benefits of many technological advances, from air conditioning to computers to advanced medical treatments—that earlier generations would envy.

“That being said, understanding the sources of the long-term tendency toward greater inequality remains a major challenge for economists and policymakers. A key observation is that, over the past few decades, the real wages of workers with more years of formal education have increased more quickly than those of workers with fewer years of formal education. For example, in 1979, median weekly earnings for workers with a bachelor's (or higher) degree were 38 percent more than those of high-school graduates with no college experience; last year, that differential was 75 percent. Similarly, over the same period, the gap in median earnings between those completing high school and those with less than a high-school education increased from 19 percent to 42 percent. To a significant extent, to explain increasing inequality we must explain why the economic return to education and to the development of skills more generally has continued to rise.

“Economists have hypothesized that technological advances, such as improvements in information and communications technologies, have raised the productivity of high-skilled workers much more than that of low-skilled workers. High-skilled workers may have enjoyed this advantage because, for example, they may have been better able to make more effective use of computer applications, to operate sophisticated machinery, or to adapt to changes in workplace organization driven by new technologies. If new technologies tend to increase the productivity of highly skilled workers relatively more than that of less-skilled workers--a phenomenon that economists have dubbed "skill-biased technical change"--then market forces will tend to cause the real wages of skilled workers to increase relatively faster. Considerable evidence supports the view that worker skills and advanced technology are complementary. For example, economists have found that industries and firms that spend more on research and development or invest more in information technologies hire relatively more high-skilled workers and spend a relatively larger share of their payrolls on them.”

http://www.federalreserve.gov/boarddocs/speeches/2007/20070206/default.htm

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The following is excerpted from a speech given by Federal Reserve Governor Randall S. Kroszner at The Forecasters Club of New York, in New York City on September 27, 2006. In it he discusses how productivity and economic growth in general are a function of investor and consumer expectations of future conditions (Say’s Law). This is why economics falls into the broad label of the ‘social sciences’:

“A good deal of research, including the Board’s large-scale econometric model of the U.S. economy, suggests that what is called Say’s law still holds. That is, in the model, an increase in the level of productivity (reflecting, for example, some technological advance) causes businesses and financial markets to revise upward their views about the level of expected profits, and it causes households to revise upward their views about the level of permanent income. The higher level of expected profits and returns to capital, in turn, lead to a rise in business investment. Similarly, personal consumption expenditures are boosted in response to the rise in permanent income. The initial increases in spending are then followed by multiplier effects. A dynamic feedback also occurs on the supply side as the higher level of investment spending increases the capital stock (relative to the supply of worker hours), which gives a small fillip to productivity and potential output. Ultimately, the increases in aggregate supply are matched by an equivalent increase in aggregate demand. This is, of course, Say’s law.

“What I’ve just described is a sketch of what happens after a one-time rise in the level of productivity. In the case of an ongoing rise in the growth rate of productivity, the dynamics and macro consequences are more complicated. In particular, all else equal, a positive shock to the growth rate of productivity will tend to put upward pressure on real interest rates. The upward pressure on real interest occurs, in part, because investment must rise to keep the growth of the capital stock in line with the faster growth of gross domestic product. In addition, a shock to the growth rate of productivity boosts household’s assessments of the growth rate of their permanent income, while increases in the expected growth rate of profits and dividends raise asset values, including the value of equities, relative to current income. The combination of faster expected growth of permanent income and higher stock market wealth tends to raise consumption relative to income and, concomitantly, lower personal saving. Thus, all else equal, the increase in demand for financing relative to domestic saving will tend to boost real interest rates.

“The dynamics of this process, and how long they take to play out, depend on several factors. One factor is how quickly the productivity change is incorporated into household and business expectations. The change in expectations can be drawn out if households and firms are slow to recognize an inflection point in the productivity growth trend or are highly uncertain about how long any observed change in the data might last. This seems to have been the case in the mid-1990s, when it took some time for that recognition to begin to sink in to the mind-set of most households and businesses. To his credit, Chairman Greenspan was one of the first to call the sea change in our productivity performance to public attention.

“Another factor influencing the dynamics of the process the degree to which businesses, financial markets and consumers are forward-looking in their economic behavior. If they are myopic in their behavior or tend to discount the future very heavily, then the dynamic response of the economy to a change in the growth rate of productivity will be drawn out.”

http://www.federalreserve.gov/boarddocs/speeches/2006/20060927/default.htm

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The following perspective is excerpted from an article included in a publication of the Federal Reserve Bank of San Francisco called FRBSF Economic Letter. It was published on April 16, 2004 and was written by Sandra E. Black and Lisa M. Lynch. The article is titled "Workplace Practices and the New Economy." It discusses how productivity gains can be realized by allowing non-managerial workers greater say in how production processes are designed and implemented:

"Since the second half of the 1990s, the growth rate of labor productivity has been faster than at any time since the 1960s, especially in the manufacturing sector. This turnaround in labor productivity had led many to wonder whether there is something “new” going on in the U.S. economy, and, if so, whether it is sustainable. The productivity growth surge is commonly associated with significant investments in capital, especially in information technology (IT) equipment and software. But, in fact, there is more to the story than just capital investments. Another part of the story is innovations in workplace practices. Over the past decade, more firms have adopted work processes in which non-managerial workers are involved in problem solving and identifying opportunities for innovation and growth. Based on earlier empirical literature on workplace innovation, Black and Lynch (forthcoming) describe four broad components of this type of innovation that are associated with productivity and wages. These components include employee voice, work design, workforce training, and incentive-based compensation. Employee voice includes organizational structures that give workers, especially non-managerial workers including lower-level production workers, a voice in making decisions about the design of the production process, as well as greater autonomy and discretion in the structure of their work. As employee voice increases, firms are better able to tap into the knowledge of non-managerial workers. The means of increasing employee voice can range from the employee suggestion box to self-managed teams of production employees. Work design innovation includes using cross-functional production processes, so that managers can have more flexibility in allocating and reallocating labor in the firm. Some examples include reengineering efforts that reduce the number of workers per supervisor or the number of levels of management within the firm, self-managed teams, and introducing or extending job rotation and job share arrangements. As work design innovations, such as teamwork, are put into place, employees need additional training to help them work effectively in a more interactive group environment. Finally, incentive-based compensation plans, such as stock options, profit sharing, and bonuses, play an important role in firms’ ability to reorganize their workplaces. By increasing the proportion of total compensation that is “at risk” and is linked to firm performance, employers hope to help realign workers’ interests towards those of shareholders. In addition, such compensation plans give non-managerial workers an incentive to come forward with ideas that would improve the production process."

http://www.sf.frb.org/publications/economics/letter/2004/el2004-10.pdf

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The following perspective is excerpted from a speech given by former Federal Reserve Chairman Alan Greenspan to the National Association for Business Economics Annual Meeting in Chicago, IL on September 27, 2005. In it he discusses how policies that engender increased flexibility for companies in hiring decisions can help increase productivity and, in turn, the standard of living for all workers:

"Flexibility is most readily achieved by fostering an environment of maximum competition. A key element in creating this environment is flexible labor markets. Many working people equate labor market flexibility with job insecurity. Despite that perception, flexible labor policies appear to promote job creation. An increased capacity of management to discharge workers without excessive cost, for example, apparently increases companies' willingness to hire without fear of unremediable mistakes. The net effect, to the surprise of most, has been what appears to be a decline in the structural unemployment rate in the United States. Protectionism in all its guises, both domestic and international, does not contribute to the welfare of American workers. At best, it is a short-term fix at a cost of lower standards of living for the nation as a whole. We need increased education and training for those displaced by creative destruction, not a stifling of competition.

Moving forward, I trust that we have learned durable lessons about the benefits of fostering and preserving a flexible economy. That flexibility has been the product of the economic dynamism of our workers and firms that was unleashed, in part, by the efforts of policymakers to remove rigidities and promote competition. Although the business cycle has not disappeared, flexibility has made the economy more resilient to shocks and more stable overall during the past couple of decades. To be sure, that stability has created some new challenges for policymakers. But more fundamentally, an environment of greater economic stability has been key to the impressive growth in the standards of living and economic welfare so evident in the United States."

http://www.federalreserve.gov/boarddocs/speeches/2005/20050927/default.htm

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The following perspective is excerpted from an article included in a publication of the Federal Reserve Bank of San Francisco called FRBSF Economic Letter. It was published on April 16, 2004 and was written by Sandra E. Black and Lisa M. Lynch. The article is titled "Workplace Practices and the New Economy." It discusses how productivity gains can be realized by allowing non-managerial workers greater say in how production processes are designed and implemented:

"Since the second half of the 1990s, the growth rate of labor productivity has been faster than at any time since the 1960s, especially in the manufacturing sector. This turnaround in labor productivity had led many to wonder whether there is something "new" going on in the U.S. economy, and, if so, whether it is sustainable. The productivity growth surge is commonly associated with significant investments in capital, especially in information technology (IT) equipment and software. But, in fact, there is more to the story than just capital investments. Another part of the story is innovations in workplace practices. Over the past decade, more firms have adopted work processes in which non-managerial workers are involved in problem solving and identifying opportunities for innovation and growth. Based on earlier empirical literature on workplace innovation, Black and Lynch (forthcoming) describe four broad components of this type of innovation that are associated with productivity and wages. These components include employee voice, work design, workforce training, and incentive-based compensation. Employee voice includes organizational structures that give workers, especially non-managerial workers including lower-level production workers, a voice in making decisions about the design of the production process, as well as greater autonomy and discretion in the structure of their work. As employee voice increases, firms are better able to tap into the knowledge of non-managerial workers. The means of increasing employee voice can range from the employee suggestion box to self-managed teams of production employees. Work design innovation includes using cross-functional production processes, so that managers can have more flexibility in allocating and reallocating labor in the firm. Some examples include reengineering efforts that reduce the number of workers per supervisor or the number of levels of management within the firm, self-managed teams, and introducing or extending job rotation and job share arrangements. As work design innovations, such as teamwork, are put into place, employees need additional training to help them work effectively in a more interactive group environment. Finally, incentive-based compensation plans, such as stock options, profit sharing, and bonuses, play an important role in firms' ability to reorganize their workplaces. By increasing the proportion of total compensation that is "at risk" and is linked to firm performance, employers hope to help realign workers' interests towards those of shareholders. In addition, such compensation plans give non-managerial workers an incentive to come forward with ideas that would improve the production process."

http://www.sf.frb.org/publications/economics/letter/2004/el2004-10.pdf

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