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November 1 4,1 980

Productivity
Slowdown:I
I
In the last Weekly Letter, we showed that the
secular (noncyclical) rate of increase of labor
productivity in the private economy declined
from a 3.2-percent annual rate over the
1 948-65 period to 2.3 percent in 1965-73,
and then to only 1.2 percent over the
1 973-78 period. (Total factor productivity-a
more inclusive concept that measures the
productivity of labor and capital combineddisplayed a similar deceleration, from 1.3
percent per year to 0.7 percent, and finally to
0.4 percent). We also showed that almost all
of the deceleration in productivity growth between the 1 948-65 and 1 973-78 periods
could be explained by broad-based declerations in ten of the nation's twelve industry
sectors.
Productivity analysts have been hard at work
attempting to pinpoint the causes of this pervasive productivity slowdown. Perhaps the
most likely candidate has been the wellpublicized slowdown of capital investment.
Empirical evidence substantiates a close
association between the degree of capital
intensity in production (the amountofcapital
employed relative to the amount of labor) and
the level of labor productivity. Labor is more
productive when it has more capital to work
with. But in addition, technological improvements normally are built into new capital
goods, so that new capital is more productive
than old. Thus, capital investment increases
total factor productivity as well as labor
productivity.

deceleration generally reflected not so much
slower growth of capital investment as more
rapid growth of labor inputs, at lea'stuntil
recent years (see chart).
The changing growth and composition of the
labor force certainly have helped to account
for the slowdown in capital deepening. The
high bi rthrate of the 1940s and 1950s and the
attempt by more women to seek employment
helped create a wave of new labor force
entrants after the mid 1960s. These developments increased the supply and decreased
the real wage of inexperienced workers,
thereby lowering the cost of inexperienced
labor relative to capital. (More accurately,
they reduced the differential by which the
cost of labor had been rising in excess of the
cost of capital). An abundant supply of relatively inexperienced labor also helped to
stimulate the growth of retail trade and service industries, such as fast-food chains,
where technology could adapt readily to the
supply of inexperienced workers.
This situation is now turning around. Since
1 973 the rate of increase in the educational
level of the U.S. labor force (a proxy for the
quality of labor) has accelerated from its prior
rate of increase, while since 1978 the number
of young persons entering the labor force has
begun to slow; Even without a change in the
growth rate of capital, these two changes will
tend to accelerate both the quality of labor
and the rate of capital deepening, and stimulate future labor-productivity growth.

Capital deepeningand labor
As much as 0.9 percentage points of the
2.0 percentage-point deceleration in laborproductivity growth between the 1948-65
and 1 973-78 periods is related to slower
growth in capital intensity (gross capital
stock/hours worked). Capital intensity increased at a 2.8-percent annual rate over the
1 948-65 period, but slowed to rates of 2.5
percent and 1.8 percent over the 1965-73
and 1 973-78 periods, respectively. Butthe

Investment: macro-policies...
The other major factor involved in productivity growth, capital investment, is a complex
phenomenon that normally involves large
entrepreneurial risk over periods of years.
Capital decisions are sensitive to the present-and more importantly, the anticipated -economic, political and regulatory
environment over the life of the investment.
Thus, such decisions depend in part on both

Opinions

expressed in this ne'vvs!eHer do not
i

nor of the Board of Covernors
Reserve Systern.

of the Federal

for the productivity slowdown, despite the
difficulty of quantifying their effects. Regulations take many forms. Some impose direct
costs on capital by requiring the diversion of
some capital expenditures to equipment that
meets environmental or safety standards,
thereby either increasing the cost of capital or
diverting some output toward nonmarketable
ends. Most studies suggest that such direct
regu Iations have had I ittle effect on aggregate
productivity growth.

macroeconomic (economic stabilization and
growth) and microeC':momic (regulatory) policies of government.
The macroeconomic climate of the 1960s
was conducive to investment. The combination of a low inflation rate, strong economic
growth, and the investment tax credit tended
to lower the cost and raise the expected return of capital during that period. Hence,
the acceleration in capital investment over
the 1 965-73 period largely reflected these
factors.

The same may not be true, however, of the
indirect effects of government regulations. A
proliferation of rules for environmental protection and increased worker health and
safety has altered production processes in
factories and offices throughout the country.
Despite their beneficial effects in terms of
cleaner air and water and healthier working
conditions, these regulations have tended to
increase measured inputs relative to measured output-i.e., to lower productivity
growth -because the benefits are not counted in measured inputs. Moreover, increases
in government-imposed paperwork and a
diversion of managerial Jesources toward
compliance undoubtedly have put a drag on
productivity. More importantly, current and
prospective regu lations have changed the
allocation of resources from what the private
market otherwise would have directed. The
costs of this reallocation of resources may
show up in part as lower overall efficiency or
productivity .

The 1970s represented a different story. Economic uncertainties, inflation, and the existing tax laws undoubtedly affected both the
level of capital investment and specific types
of investments. The 1 974-75 recession was
the most severe in the postwar period, and
uncertainties surrounding future economic
growth characterized the decade. High and
variable inflation rates created further uncertainties. Equally important, rampant inflation
increased the effective tax burden imposed
on capital investment during this period.
For one reason, depreciation must be calculated for tax purposes on the basis of historical (rather than replacement) cost. With
accelerating inflation, depreciation write-offs
have been inadequate to cover capital replacement costs, and profits -the bottom
line of the income statement -have been
unavoidably overstated. Since stated profits
("real" or otherwise) are taxed, inadequate
depreciation write-offs have increased the
effective tax on capital. Second, inflation has
increased the levels of nominal interest rates,
rates of return, and capital gains needed to
compensate lenders and equ ity-owners for
the loss of purchasing power on their investments. Yet, the higher yields are taxed as if
they were ordinary income. In both these
ways, therefore, the combination of inflation
and existing tax legislation works to increase
the cost of capital and to deter investment.

Earlier studies concluded that higher energy
prices had contributed significantly to the
productivity slowdown of the mid-decade.
More recent analyses, in contrast, have found
little energy impact, based on actual energyusage data and evidence regarding substitutability among energy, capital, and labor inputs. Although higher energy prices certainly
have reduced real consumption and affected
the design and choice of new capital equipment, their effect on aggregate productivity
growth apparently has been small to date .

. . . and micro-policies
Some economists attribute at least part of the
productivity slowdown to retarded spending

Government regulations-present and prospective-have received much of the blame
2

underlying causes ofthe slowdown in capital
deepening also remain difficult to identify
with certainty.

for research and development, which has
declined as a share of GN P since the late
1960s. (The research and development decline came about largely because of a reduction in government defense expenditures.)
Other analysts argue, however, thatthe link is
weak between R&D (particularly government-sponsored R&D) and productivity. A
reduction in the growth of R&D spending
may be a factor in the productivity slowdown, but it appears to explain only a small
portion of the deceleration.

Labor-force growth will slow dramatically in
the 1980s, imparting a positive boost to capital deepening and to labor productivity, even
in the face of a further modest decline in
capital-investment growth. But the direction
and extent of capital investment is highly uncertain. Much depends on whether we overcome our recent problems, such as severe
business cycles, a high andvariable rate of
inflation, and increasing taxation and regulations. Moreover, prediction is made difficult
by our lack of understanding of hbw these
negative factors impacted on productivity in
the 1970s. Until we can understand the
causes of that slowdown more fully, we shall
have difficulty making a prognosis for the
1980s.
.

Uncertain future
Unfortunately, we are left with many potential causes of the productivity slowdown,
most of which cannot be quantified accurately. A small part of the slowdown (about 15
percent) results from intersectoral shifts,
while a much larger part (almost half) is related to a slower growth in capital deepening.
That sti II leaves much of the productivity
slowdown urlexplained, and moreover, the

Jack Beebeand JaneHaltmaier

Annual Average
Change(%)

4.0

Capital - Labor Growth
Capital

3.0

Capital-labor
ratio "'

2.0

to

1 948-65

1 965-73

3

1 973-78

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BAN KING DATA-TWELF TH FEDERAL
RESERVE
DISTRICT
(Dollaramounts millions)
in
SelectedAssetsand Liabilities
Large Commercial Banks

Loans
(gross,
adjusted) investments*
and
Loans
(gross,
adjusted) total#
Commercial industrial
and
Realestate
Loans individuals
to
Securities
loans
U.s. Treasury
securities*
Othersecurities*
Demanddeposits total#
Demanddeposits adjusted
Savings
deposits total
Time deposits total#
Individuals,
part.& corp.
(Large
negotiable
CD's)
Weekly Averages
of Daily Figures

Amount
Outstanding

Change
from

10/29/80

10/22/80

141,878
119,811
35,023
48,929
23,730
1,152
6,663
15,404
44,226
33,072
29,772
65,570
56,716
25,104

271
220
23
172
56
33
9
42
185
24
13
619
451
688

-

-

Change
from
yearago
Dollar
Percent

-

-

Weekended

Weekended

10/29/80

10/22/80

51
132
81

66
146
211

6,298
7,374
2,815
6,902
133
533
776
300
1,102
1,703
398
8,799
8,279
4,367

4.6
6.6
8.7
16.4
0.6
31.6
- 10.4
1.9
2.4
5.4
1.4
15.5
17.1
21.1

Comparable
year-ago
period

Member Bank ReservePosition

Excess
Reserves )/Deficiency- )
(+
(
Borrowings
Net freereserves+ )/Netborrowed( )
(
-

-

45
125
80

* Excludes
tradingaccountsecurities.
# Includesitemsnot shownseparately.
Editorial comments may beaddressed the editor (William Burke) or to the author . . , . Freecopiesof this
to
and other FederalReserve
publicationscan beobtained by calling or writing the Public Information Section,
Federal ReserveBank of SanFrancisco,P.O, Box 7702, SanFrancisco94120. Phone (415) 544-2184.

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