View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

For release on delivery
12:30 p.m. EDT
August 31, 2006


Ben S. Bernanke
Board of Governors of the Federal Reserve System
Leadership South Carolina
Greenville, South Carolina
August 31, 2006

One of the most important economic developments in the United States in the past
decade or so has been a sustained increase in the growth rate of labor productivity, or
output per hour of work. From the early 1970s until about 1995, productivity growth in
the U.S. nonfarm business sector averaged about 1-1/2 percent per year--a
disappointingly low figure relative both to U.S. historical experience and to the
performance of other industrial economies over the same period.1 Between 1995 and
2000, however, the rate of productivity growth picked up significantly, to about 2-1/2
percent per year--a figure that contributed to the view, held by many at the time, that the
United States might be entering a new economic era.
Talk of the “new economy” faded with the sharp declines in the stock valuations
of high-tech firms at the turn of the millennium. Yet, remarkably, productivity
accelerated further in the early part of this decade. From the end of 2000 to the end of
2003, productivity rose at a 3-1/2 percent annual rate and, even after recent downward
revisions to the data, it is estimated to have increased at an average annual rate of 2-1/4
percent since the end of 2003. These advances were achieved despite adverse
developments that included the 2001 recession, the terrorist attacks of September 11,
corporate governance scandals, and in the past few years, devastating hurricanes and very
substantial increases in the cost of energy.
Why is the rate of productivity growth so important? Economists agree that, in
the long run, productivity growth is the principal source of improvements in living
standards. The logic is simple: In the long run, what we can consume as a nation is
closely tied to how much we can produce. The link between the growth of productivity
and the standard of living of the average person is somewhat looser in the short-to-

-2medium run, because variation in factors such as the share of the population that is
employed, the division of income between capital and labor, and the distribution of each
type of income across households also matters. Nevertheless, the rate of productivity
growth influences the economy in important ways even in the short run, affecting key
variables such as the growth rate of output, employment gains, and the rate of inflation.
Today I will discuss the acceleration of productivity that has occurred over the
past decade and our current understanding of its causes. In the discussion I will comment
on two puzzles raised by this improved performance and then conclude by briefly
addressing the longer-term prospects for productivity growth in the United States.
The U.S. Productivity Resurgence and Its Causes
What underlies the resurgence in U.S. productivity growth? Explanations of the
rise in productivity growth since about 1995 have evolved somewhat over time. By 2000
or so, an emerging consensus held that the pickup in productivity growth was, for the
most part, the product of both rapid technological progress and increased investment in
new information and communication technologies (IT) during the 1990s (see Jorgenson
and Stiroh, 2000, and Oliner and Sichel, 2000). According to this view, developments in
IT promoted U.S. productivity growth in two ways. First, technological advances
allowed the IT-producing sectors themselves to exhibit rapid productivity growth. For
example, the development of more-reliable semiconductor manufacturing equipment and
faster wafer-inspection technologies increased the rate at which companies such as Intel
were able to produce microprocessors. Intel was also able to shorten its product cycle
and increase the frequency of new chip releases, shifting its product mix toward morepowerful and, consequently, higher-value chips. Both the more-rapid pace of production

-3and the higher average quality of output raised productivity at Intel as well as at
competing firms that were forced to keep pace.
Second, advances in information technology also promoted productivity growth
outside the IT-producing sector, as firms in a wide range of industries expanded their
investments in high-tech equipment and software and used the new technologies to
reduce costs and increase quality. Some large retailers, for example, developed IT-based
tools to improve the management of their supply chains and to increase their
responsiveness to changes in the level and mix of customer demands. Securities brokers
and dealers achieved substantial productivity gains by automating their trading processes
and their back-office operations. In the durable goods sector, automobile producers
developed programmable tooling systems to increase the flexibility of their
manufacturing processes--for example, to permit vehicles based on different platforms to
be produced on the same assembly line. One study (Stiroh, 2002) found that a majority
of U.S. industries experienced an acceleration of productivity in the latter part of the
1990s. Significantly, the study also found the gains to be the greatest in industries that
use IT capital most intensively.
Undoubtedly, the IT revolution and the resurgence of productivity in the United
States after 1995 were closely connected. However, the technology-based explanation of
increased productivity growth does raise a couple of puzzles (see, for example, McKinsey
and Company, 2001 and 2005, and Basu and others, 2003). First, the United States was
not the only country to have access to the new technologies or to have experienced a
rapid expansion in IT investment; other industrial countries also invested heavily in these
technologies in the 1980s and 1990s. Yet, with a few exceptions, the available data show

-4that productivity growth in other advanced countries has not increased to the extent seen
in the United States. Second, as I have noted, productivity growth increased very rapidly
earlier this decade and has continued to rise at a solid pace, even though IT investment
declined sharply after the stock prices of high-tech firms plummeted in 2000. More
generally, as a historical matter, increases in IT investment have not always been
followed in short order by increases in productivity growth. This observation raises the
question of why, in some cases, the putative productivity benefits of investments in new
technologies do not occur until years after those investments are made.
In regard to the first puzzle--the fact that the United States has enjoyed greater
productivity growth in recent years than other advanced countries--the comparison with
Europe is particularly interesting. Throughout most of the post-World War II period,
productivity growth in Europe exceeded that in the United States, at first because of the
rapid gains during the postwar reconstruction and then later because of a gradual
convergence of European technology and business practices to American standards. By
one estimate, European productivity increased from 44 percent of the U.S. level in 1950
to near-equality with the United States by 1995 (Gordon, 2004 and 2006). However, the
available data suggest that, since about 1995, productivity growth in European nations
has slowed, on average, in contrast to the pickup experienced in the United States. These
trends have led to an increasing divergence in productivity levels in the United States and
Europe (see van Ark and Inklaar, 2005).
Researchers have made the important point that differences in productivity growth
between the United States and Europe appear not to have been particularly large in the
IT-producing sectors, where U.S. strengths in the development of computers and

-5semiconductors have been partly offset by European leadership in communications.
Rather, the U.S. advantage has been most evident in the IT-using sectors, which have
performed better in the United States than elsewhere. What accounts for this apparent
U.S. advantage?
Differences in economic policies and systems likely have accounted for some of
the differences in the performance of productivity. One leading explanation for the
strong U.S. productivity growth is that labor markets in the United States tend to be more
flexible and competitive, market characteristics that have allowed the United States to
realize greater economic benefits from new technologies. For example, taking full
advantage of new information and communication technologies may require extensive
reorganization of work practices, the reassignment and retraining of workers, and
ultimately some reallocation of labor among firms and industries. Regulations that raise
the costs of hiring and firing workers and that reduce employers’ ability to change work
assignments--like those that exist in a number of European countries--may make such
changes more difficult to achieve.
Likewise, in product markets, a high degree of competition and low barriers to the
entry of new firms in most industries in the United States provide strong incentives for
firms to find ways to cut costs and to improve their products. In some other countries, in
contrast, the prominence of government-owned firms with a degree of monopoly power,
together with a regulatory environment that protects incumbent firms and makes the entry
of new firms difficult, reduces the competitive pressure for innovation and the application
of new ideas. For example, some economists have argued that restrictions on land use
and on shopping hours in Europe have impeded the development of “big box” retail

-6outlets, reducing competition and denying European firms the economies of scale that
have been important for productivity growth in the retail sector in the United States
(Gordon, 2004). More generally, recent empirical research has typically found that
economies with highly regulated labor and product markets are indeed less able to make
productive use of new technologies (Gust and Marquez, 2004). Also, although it is not a
feature unique to the United States, the increasing degree of openness of our economy to
trade and foreign investment and the consequent exposure of U.S. companies to the rigors
of international as well as domestic competition, may have promoted productivity
growth.2 As a leading example, productivity gains in U.S. manufacturing--which is
particularly subject to international competition--have been especially impressive in
recent years, averaging, by one measure, about 6 percent per year over the past decade.3
A number of other explanations have been advanced for the relatively stronger
performance of productivity in the United States in recent years, including international
differences in management practices, the depth and sophistication of U.S. capital
markets, more favorable attitudes toward competition and entrepreneurship in the United
States, and the role of U.S. research universities in fostering innovation. 4 Further study
of national productivity differentials clearly is warranted.
The second productivity puzzle relates to the further acceleration in productivity
that occurred earlier in this decade despite the decline in IT investment after 2000 and the
rather modest recovery in recent years.5 Again, a number of explanations have been
proposed, including business restructuring and an even more rapid pace of technical
change and of the diffusion of technological advances. It is interesting, however, that the
recent episode is not the first time that we have seen productivity improvements lagging

-7well behind investments in new technology. Notably, computers were first
commercialized in the 1950s, and personal computers began to come into widespread use
in the early 1980s; but until the mid-1990s, these developments had little evident effect
on measures of productivity. Indeed, an oft-quoted quip by economist Robert Solow held
that, as of the late 1980s, “computers are everywhere except in the productivity
In attempting to explain the tendency of productivity growth to lag behind
investments in new technologies, economists have emphasized that much more than the
purchase of new high-tech equipment is needed to achieve significant gains in
productivity. In particular, to be successful, managers must have a carefully thought-out
plan for using new technologies before they acquire them. Case studies of individual
industries show that the planning for technological modernization has not always been
adequate, with the result that some purchases of high-tech equipment and software have
not added much to productivity or profits. The idea that managers can buy the hardware
first and then decide what to do with it does not square with the evidence.
Some observers have characterized the new information and communication
technologies as general-purpose technologies, which means that--like earlier major
innovations such as electrification and the internal combustion engine--they have the
potential to revolutionize production and make many new goods and services available to
consumers (see Bresnahan and Trajtenberg, 1995). To make effective use of such a
technology within a specific firm or industry, however, managers must supplement their
purchases of new equipment with investments in firm- or industry-specific research and
development, worker training, and organizational redesign--all examples of what

-8economists call intangible capital. Although investments in intangible capital are, for the
most part, not counted as capital investment in the national income and product accounts,
they appear to be quantitatively important.6 One recent study estimated that, by the late
1990s, investments in intangible capital by U.S. businesses were as large as investments
in traditional tangible capital such as buildings and machines (Corrado, Hulten, and
Sichel, 2006).
Recognizing the importance of intangible capital has several interesting
implications. First, because investment in intangible capital is typically treated as a
current expense rather than as an investment, aggregate saving and investment may be
significantly understated in the U.S. official statistics. Second, firms’ need to invest in
intangible capital--and thus to divert resources from the production of market goods or
services--helps to explain why measured output and productivity may decline or grow
slowly during the period after firms adopt new technologies. Finally, the concept of
intangible capital may shed light on the puzzle of why productivity growth has remained
strong despite the deceleration in IT investment. Because investments in high-tech
capital typically require complementary investments in intangible capital for productivity
gains to be realized, the benefits of high-tech investment may become visible only after
an extended period during which firms are making the necessary investments in
Longer-Term Prospects for Productivity Growth
Historical analyses of the sources of fluctuations in productivity growth are
challenging, but not nearly so challenging as trying to predict how productivity will
evolve in the future. However, because the rate of productivity growth is a primary

-9determinant of economic performance, policymakers have few options other than to try to
forecast future gains in productivity. For example, estimates of long-term productivity
growth are needed to determine the rate of output growth that the economy can sustain in
the long run without generating inflationary pressures.
The task of trying to predict the behavior of productivity in the medium-to-long
run is complicated by the fact that productivity growth generally varies with the business
cycle, tending to be below its longer-term trend when the economy is contracting and
above that trend when the economy is in the early stages of an expansion (see Basu and
Fernald, 2001, for a discussion). (This well-documented pattern makes the strong growth
of productivity during the early part of this decade, a period that featured a recession and
generally slow growth, all the more remarkable.) Economists use statistical methods to
try to abstract from cyclical influences to determine the longer-term trend in productivity.
What do they find?
As of a couple of years ago, the consensus among leading researchers was that
productivity in the nonfarm business sector was likely to grow at about 2-1/2 percent per
year in the longer term, close to the rate of productivity growth achieved during the 1995
to 2000 period (see, for example, Baily, 2003; Gordon, 2003; and Jorgenson, Ho, and
Stiroh, 2004). On the one hand, recent data revisions to the national income and product
accounts have shown that productivity growth over the past few years was slightly
weaker than we thought, leading some analysts to revise down their estimates of trend
productivity growth about 1/4 percentage point or so per year. On the other hand, the fact
that productivity growth has remained solid in recent years increases confidence that a
larger fraction of those productivity gains reflects longer-term developments and a

- 10 smaller fraction reflects cyclical factors. On net, the recent experience does not appear to
require a significant rethinking of long-term productivity trends. Indeed, recent estimates
by leading economists continue to peg the expected longer-term rate of productivity
growth at roughly 2-1/2 percent per year.7
Of course, as the saying goes, past returns do not guarantee future results, and not
all the evidence supports this optimistic view of productivity trends. For example,
although spending on high-tech equipment and software has recovered noticeably from
its recent lows, growth in IT spending remains well below the rates observed before the
2001 recession. Some industry participants have suggested that less-rapid growth in IT
spending may reflect the absence of major new business applications for IT--“killer
apps,” as they are called. Moreover, until we have a more complete understanding of the
factors behind productivity growth in the past five years, we should be cautious in
drawing any strong conclusions about the future.
These caveats notwithstanding, a case can be made that the strong productivity
growth of the post-1995 era is likely to continue for some time. Notably, the price of
computing power continues to fall sharply, having declined by nearly half in the five
years between 2000 and 2005. Increased computing power has in turn contributed to
advances in other fields, such as biotechnology, and has helped to increase the range of
goods and services available to businesses and consumers. Moreover, whatever the pace
of future technological progress, further diffusion of already-existing technologies and
applications to more firms and industries should continue to increase aggregate
productivity for a time.

- 11 I have focused today on how technological change and investment, both tangible
and intangible, promote productivity growth. I will close by noting that, from the
perspective of society as a whole, a particularly important form of intangible investment
in future years will be investment in the skills of the U.S. labor force. As we know from
everyday experience, few jobs or occupations have not been affected in some way by the
technological changes of recent years, a trend that will certainly continue. Not only
scientists and engineers but also nurses, auto mechanics, and factory workers now use
advanced technologies every day. But new technologies will translate into higher
productivity only to the extent that workers have the skills needed to apply them
effectively. Moreover, because technology is always changing, the acquisition of those
skills has become a lifelong challenge, one that continues well after formal education is
completed. If the recent gains in productivity growth are to be sustained, ensuring that
we have a workforce that is comfortable with and adaptable to new technologies will be

Baily, Martin (2003). “The U.S. Economic Outlook: Investment, Productivity,
Deflation.” Washington: Institute for International Economics (April)
Basu, Susanto, and John Fernald (2001). “Why is Productivity Procyclical? Why Do We
Care?” in C. Hulten, E. Dean, and M. Harper, eds., New Developments in Productivity
Analysis, National Bureau of Economic Research, Studies in Business Cycles. Chicago:
University of Chicago Press, pp. 225-296.
Basu, Susanto, John Fernald, Nicholas Oulton, and Sylaja Srinivasan (2003). “The Case
of the Missing Productivity Growth, or Does Information Technology Explain Why
Productivity Accelerated in the United States but not the United Kingdom?” NBER
Macroeconomics Annual, vol. 18, pp. 9-71.
Bloom, Nick, Raffaella Sadun, and John Van Reenen (2006). “It Ain’t What You Do, It’s
the Way You Do I.T.: Investigating the Productivity Miracle Using the Overseas
Activities of U.S. Multinationals,” working paper. London: Centre for Economic
Performance, London School of Economics (May).
Bosworth, Barry, and Jack Triplett (2006). “Is the 21st Century Productivity Expansion
Still in Services? And What Should Be Done About It?” paper presented at the 2006
Summer Institute sponsored by the National Bureau of Economic Research and the
Conference on Research in Income and Wealth, held in Cambridge, Mass., July 17.
Bresnahan, Timothy, and Manuel Trajtenberg (1995). “General Purpose Technologies:
‘Engines of Growth’?” Journal of Econometrics, vol. 65 (January), pp. 83-108.
Corrado, Carol, Paul Lengermann, Eric Bartelsman, and J. Joseph Beaulieu (2006).
“Modeling Aggregate Productivity at a Disaggregate Level: New Results for U.S. Sectors
and Industries,” paper presented at the 2006 Summer Institute sponsored by the National
Bureau of Economic Research and the Conference on Research in Income and Wealth,
held in Cambridge, Mass., July 17.
Corrado, Carol, Charles Hulten, and Daniel Sichel (2006). “Intangible Capital and
Economic Growth,” Finance and Economics Discussion Series 2006-24. Washington:
Board of Governors of the Federal Reserve System, April.
Gordon, Robert J. (2003). “Exploding Productivity Growth: Context, Causes, and
Implications,” Brookings Papers on Economic Activity, 2:2003, pp. 207-98.
Gordon, Robert J. (2004). “Why Was Europe Left at the Station When America’s
Productivity Locomotive Departed?” Working Paper Series 10661. Cambridge, Mass.:
National Bureau of Economic Research, August.
Gordon, Robert J. (2006). “Issues in the Composition of Welfare Between Europe and the
United States,” unpublished paper, Northwestern University (July).

- 13 -

Gust, Christopher, and Jaime Marquez (2004). “International Comparisons of
Productivity Growth: The Role of Information Technology and Regulatory Practices,”
Labour Economics, vol. 11 (February), pp. 33-58.
Jorgenson, Dale, and Kevin Stiroh (2000). “Raising the Speed Limit: U.S. Economic
Growth in the Information Age,” Brookings Papers on Economic Activity, 1:2000, pp.
Jorgenson, Dale, Mun Ho, and Kevin Stiroh (2004). “Will the U.S. Productivity
Resurgence Continue?” Current Issues in Economics and Finance, vol. 10 (December),
pp. 1-7.
Jorgenson, Dale, Mun Ho, and Kevin Stiroh (2006). “The Sources of the Second Surge of
U.S. Productivity and Implications for the Future,” unpublished paper, Federal Reserve
Bank of New York, March.
Lewis, William W. (2004). The Power of Productivity: Wealth, Poverty, and the Threat
to Global Stability. Chicago: The University of Chicago Press.
McKinsey and Company (2001). U.S. Productivity Growth 1995-2000: Understanding
the Contribution of Information Technology Relative to Other Factors. Washington:
McKinsey Global Institute.
McKinsey and Company (2005). “U.S. Productivity after the Dot-Com Bust,” perspective
paper. Washington: McKinsey Global Institute.
Oliner, Stephen, and Daniel Sichel (2000). “The Resurgence of Growth in the Late
1990s: Is Information Technology the Story?” Journal of Economic Perspectives, vol. 14
(Autumn), pp. 3-22.
Stiroh, Kevin (2002). “Information Technology and the U.S. Productivity Revival: What
Do the Industry Data Say?” American Economic Review, vol. 92 (December), pp. 155976.
Stiroh, Kevin (2006). “The Industry Origins of the Second Surge of U.S. Productivity
Growth,” unpublished paper, Federal Reserve Bank of New York, July.
van Ark, Bart, and Robert Inklaar (2005). “Catching up or Getting Stuck? Europe’s
Trouble to Exploit ICT’s Productivity Potential,” Research Memorandum GD-79.
Groningen, The Netherlands: Groningen Growth and Development Centre, September.

- 14 -


I will use “labor productivity” and “productivity” interchangeably in my remarks today. An alternative
productivity concept, multifactor productivity, measures the quantity of output that can be produced by a
given combination of capital and labor. Changes in labor productivity reflect changes in both multifactor
productivity and the amount of capital per worker.
Lewis (2004) discusses the link between competition and productivity.
The figure for growth in output per hour in the text uses the Federal Reserve’s industrial production index
for the manufacturing sector as the measure of output.
Regarding differences in management practices, Bloom, Sadun, and Van Reenen (2006) found that
business establishments in the United Kingdom that are owned by U.S. multinationals get higher
productivity from information technology than do other establishments in that country. Their study tied the
differential to the management and organizational practices employed by U.S. firms.
Indeed, productivity accelerated in a wide range of industries that had not experienced much improvement
in productivity growth in the 1990s. For discussions of more recent developments at the industry level, see
Corrado, Lengermann, Bartelsman, and Beaulieu (2006), Bosworth and Triplett (2006), and Stiroh (2006).
Software is one intangible investment that is treated as part of business fixed investment in the U.S.
national accounts.
Martin Baily puts the trend for the nonfarm business sector a little above 2-1/2 percent (conversation with
Board staff in August 2006). Robert Gordon reports a current trend of 2.6 percent but predicts that it will
move lower in the next couple of years (conversation with Board staff in August 2006). Jorgenson, Ho,
and Stiroh (2006) put the trend at 2.6 percent for the private economy (a sector quite close to nonfarm
business), but that figure was generated before the recent NIPA revisions.