Much has been made of the US productivity "miracle" which, it is claimed, will enable continuing strong growth without provoking inflation. The logic behind this premise is that the widespread introduction of computer technology and increased levels of competition have revolutionised the way business is done in the US. As a result, a "New Paradigm" is said to exist where businesses are more efficient, and inflation has become a feature of the past. This story is often set against the "failure" of Europe which, it is argued, has not engaged the information-technology revolution and is too regulated to succeed in the modern world.
Advocates of the "New Paradigm" are so certain that the US has entered an era of higher productivity growth, and that Europe is stuck in the productivity doldrums, that it must never have occurred to them to check the data. But, before examining the evidence, you may ask: why is productivity so important?
Productivity (defined as output/employment) is the lifeblood of economic growth and the key determinant of a nation's standard of living. While a country can achieve periods of rapid growth when rebounding from a recession or when there is a shift in demographics, faster productivity gains are the only means of achieving a sustainable higher rate of growth. Therefore, while Ireland's rapid employment growth over the past 10 years has been remarkable, its average productivity growth of 4 per cent a year over the same period provides the principal grounds for confidence about the future.
While productivity is an important issue in general, US productivity growth is critical to financial markets at the moment. If productivity growth has accelerated permanently, the heights that US equity prices have reached (both in absolute terms and relative to European equities) might be justified by the advent of this new era. If productivity growth remains ordinary, then the US has simply reached the final stages of an unsustainable boom.
Thus the two fundamental issues are:
(1) Whether US productivity growth has accelerated significantly.
(2) Whether US productivity growth surpasses that of the EU.
A look at the evidence provides some interesting answers. OECD data on productivity growth in the US shows that, while there has been a moderate improvement during the 1990s, this has only brought the US into line with what the EU achieves on an annual basis.
Over the past 20 years, EU productivity has consistently risen by about 2 per cent every year while the US has struggled to achieve growth of more than 1 per cent a year. US productivity growth has consistently been below Europe's with two very brief exceptions (in 1985 and 1998). At the moment, US productivity growth is relatively close to what the EU achieves on an annual basis, but it is heading downwards once more.
If the US's productivity performance has been so ordinary, how has its GDP growth managed to overtake the EU in recent years? Data shows that this was achieved through faster employment growth. This is partly due to demographics: the US labour force is growing at a quicker rate than Europe's due to a higher post-war birth rate.
However, the main explanation is the demand-induced decline in the US's unemployment rate. (One valid element of the received wisdom on the US versus Europe is that the absence of US labour market rigidities has enabled unemployment to fall to a level that would not be achievable in the EU.) However, the key point here is that, though the decline in US unemployment to only 4.2 per cent is impressive, the scope for a further decline is very limited.
If you work in an office environment, you probably find it difficult to believe that information technology has had such a limited impact on productivity. Given the amazing pace of development in computer speeds, email, the Internet, etc, why has productivity growth not risen by more?
The answer is that today's new technologies are no more revolutionary than yesterday's. The latest technology always appears to be ingenious. After the first flight of the Boeing 247, a twin-engine plane that carried 10 people, the chief engineer of the project announced: "There will never be a bigger plane built".
America's real golden economic era took place during the 1950s and 1960s when productivity growth was more than twice the 1 per cent rate achieved over the previous three decades. There is very little evidence to suggest that the US is entering another golden era. Moreover, there is a large amount of evidence to suggest that the US economy is experiencing an unsustainable bubble. The US "miracle" will very soon be over.
And what of Europe? In time, a gradual cyclical recovery combined with a US slowdown will eliminate Europe's "respect deficit". However, this would be achieved sooner if the ECB were more aggressively expansionary and if continental Europe engaged in some real labour market reforms.
Kevin Daly is European Economist with Credit Lyonnais Securities Europe. kevin.daly@creditlyonnais.co.uk
