The Economy by Peter R. Crabb: Slowed productivity impedes increase in standard of living

PETER R. CRABB, professor of finance and economics at Northwest Nazarene University in NampaAugust 6, 2013 

Peter R. Crabb

Are you better off than your parents and grandparents? The economic data say yes, but the economic forecast says your children and grandchildren won’t be doing much better than you.

The U.S. Bureau of Economic Analysis reported last week that real gross domestic product, the basic economic measure of our standard of living, grew at an annualized rate of 1.7 percent in the second quarter of this year. This rate topped forecasts and exceeded the first quarter rate of 1.1 percent.

But realize that the 1.7 percent rate is low from a historical perspective. And if the rate of growth in inflation-adjusted GDP doesn’t pick up soon, there is a good possibility of losing a generation of gains.

When it comes to economic analysis, the rate of change is often more important than the current level of any variable. This is particularly true when discussing the overall economy and gross domestic product. Economic growth is important because this is how new businesses form, new customers are found and our standard of living improves.

The rule of 72 is process of division used to obtain the approximate number of periods required for doubling any variable. In economic terms, the rule of 72 is used to determine when a country’s standard of living will double — how long will it be before our way of life is twice as good.

If the economy grows at a 2 percent real rate of return — its long-run historical average — it takes approximately 36 years for the standard of living to double. For just about every other generation in America, the standard of living has doubled. My standard of living is twice my grandparents, and so on.

But the U.S. economy over the last five years has averaged only 1 percent annual growth measured quarterly. At this rate it takes more than 70 years to double our standard of living.

Economic theory and historical experience show that productivity is the ultimate source of GDP growth and better living standards. Since 1950 the output per hour worked in the non-farm sector of the United States has grown at an average of more than 2 percent per year. Our standard of living is much better than our parents and grandparents because workers and businesses keep finding ways to produce more with less.

However, the rate of increase in productivity over the past five years has slowed to 1.5 percent annually. Lower productivity growth will show itself in slower economic growth over time.

At the state level, productivity is roughly measured by dividing private sector output in the state by total employment, and Idaho is experiencing a similar decline to that of the nation. From 1998 to 2008, productivity in Idaho grew at an average annual rate of 2.8 percent, but since 2008 the rate of increase has slowed to less than 2 percent.

So how do we improve productivity? Economic theory and historical experience show that productivity is determined by the amount of physical capital, human capital and natural resources each worker has at his or her disposal, along with the technological knowledge to use all these resources. When businesses invest in these resources and develop new technologies to use them, productivity grows faster.

Much of the slow growth we are experiencing is due to low levels of investment. You’ll be better off than your parents and grandparents when the incentives for businesses to invest improve.


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