The Fragile Roots of Productivity Growth

How fast is the US economy now growing? Smart investors are now betting that the most recent economic data will show an annual GDP growth rate of 3% for the second quarter of 2003. They are also betting that the current third quarter may well show a growth rate as high as 5% per year. July saw American industrial production jump by half a percent, while Intel, the big microprocessor maker, is reporting very strong growth in demand for its key products, suggesting that business investment spending is finally accelerating.

Although Japan continues to stagnate, and Western Europe hovers on the edge of recession, a solid "output-growth" recovery in the US should prove to be a big help in boosting demand in the rest of the world. But this good news about the US business cycle has been accompanied by bad news about employment. Hours worked in American business fell at a 2.7% annual rate in the second quarter. Employment-particularly manufacturing employment-fell in July. It is very likely that hours worked will continue to fall in the third quarter.

What accounts for this wide divergence? How can America see reasonably rapid output growth and yet rising unemployment? The answer is that the underlying trend of productivity growth in the American economy continues to be exceptionally positive. The 5.7% annual productivity gain recorded in the second quarter seems likely to be matched in July-September. With America's workers producing more in less time, it is no wonder that a wedge is being driven between the (good) output news and the (bad) employment news.

In the short run, rapid productivity growth poses dilemmas for macroeconomic management, because what would otherwise be seen as reasonably strong demand growth is proving to be insufficient to keep unemployment low. But the short-run view is not the important one.