Global Productivity Drag: The Low Spark of a High-Tech World

The pace of life in the global economy has never felt faster, an always-on-demand, connected world built for speed, disruption and transformation, yet gains in productivity have slowed sharply and are dragging on global growth.

The latest sign of the times? After years of tepid productivity growth, the U.S. economy saw an outright drop in output per hour in the second quarter of 2016, marking “what is now the worst run since 1979," says Morgan Stanley Global Economist Elga Bartsch. This weakness is pervasive across developed markets, and will likely persist. Productivity growth—which is the increase in output per unit of input—is the lifeblood of dynamic economies. Any slowdown can have “profound macroeconomic consequences," Bartsch says, adding: “It limits wage income growth and increases margin pressure on corporate profitability."

In a new report, Bartsch and her Co-Head of Global Economics, Chetan Ahya, look at the causes and effects of sluggish growth and conclude: “Our cautious outlook isn't simply a near-term cyclical call, but a reflection of factors that are inhibiting long-term growth." Morgan Stanley's estimate for annual growth across developed markets is 1.25%, a quarter of a percentage point lower than the market consensus and official forecasts. Contrast this to the 2.75% annual gains of the late 1990s. “An annual shortfall of 1.5 percentage points makes a major difference in the long run," says Bartsch. “Instead of GDP doubling every 25 years, it now takes 56 years to double."

Yet, they also point to a number of solutions, including structural reforms, removing barriers to trade, and increasing spending on public infrastructure, that could help shift the gears of productivity higher.

Most economists agree that falling productivity gains are cause for concern, but often disagree on what is responsible for the slowdown. Some believe the drop-off is primarily cyclical, a hangover from the Great Recession, when companies cut jobs and costs, relying on a mantra of “less is more.” Even as economic and business conditions have improved over the years, many of these companies continue to be cautious about investing capital to improve productivity.

Others chalk it up to mismeasurement: Productivity measures don't account for quality improvements or, say, the use of now ubiquitous tech tools, such as free Internet search engines or other online and mobile services. However, “for measurement issues to explain the downtrend, the error would have to consistently increase over time, which it has not," notes Bartsch.

Still others argue that today's technological gains are no match for the advances made in the previous century, when electricity made it possible to work longer hours and transportation paved the way for more competition and logistical efficiencies. Indeed, certain advances, such as smartphones, may make us feel more productive, but they don't necessarily translate into more efficient use of capital and labor outputs.

Bartsch and Ahya believe the roots of the productivity problem go deeper—and call for more meaningful solutions. The slowdown in productivity growth can’t be blamed on weak labor markets. “Employment has risen close to historical highs in key developed markets," says Bartsch. “Yet, workers aren’t being equipped with more powerful machines or more efficient technology." Meanwhile, easy monetary policy, coupled with a slower rate of new business formation, may allow relatively unproductive companies to stay alive.

Another factor that seems to limit productivity: The lack of diffusion between sectors and countries. In other words, the changes and improvements that drive material gains in productivity in one industry or marketplace don’t always travel very far or translate fluently. Entrenched legacy structures, technologies, and vested interests often work against the adoption of new approaches. Rising protectionism, whether it’s between borders, or within them, can impede mobility and stall the embrace of often disruptive changes.

Bartsch takes a hard look at the U.S., which until recently had been riding the leading edge of productivity gains. “Looking at different sectors within the U.S. economy since the 1950s, a recent study establishes that productivity growth within the same sector has not slowed," she says. What has slowed: The gains in overall productivity growth that come from shifts between sectors when less productive industries adopt the best practices of leading industries. Since the 1990s, this kind of sector diffusion has materially decelerated, with outright decline since 2005, several years before the Great Recession hit.

The same is true about how innovation moves across borders. At the same time that diffusion can help close the gap between high- and low-performing nations, global value chains demand that companies adopt efficiencies to compete. In fact, some economists contend that the Internet wasn't solely responsible for the surge in U.S. productivity in the late 1990s and early 2000s, but that the rapid expansion of global trade during that time also played a role.

“Only in a flexible economic setting can the efficiency gains driven by technological innovation take hold and be transferred across countries," says Bartsch, noting that global trade growth has slowed since the financial crisis. “The latter is particularly important for countries that are still a good distance away from the technology frontier."

While the debate over productivity continues, new gains may ultimately come from automation, which carries its own risks. Whereas previous phases in automation primarily displaced blue-collar workers, the next wave of automation will likely affect white-color workers, from legal assistants to computer programmers.

Against the current macroeconomic backdrop—not to mention a volatile political environment—weak productivity growth will likely drag on global GDP growth for the foreseeable future. Morgan Stanley is currently forecasting 2.9% GDP growth in 2016, down from 3.1% in 2015. A rebound in emerging markets in 2017 could help offset slower growth in the U.S., Europe and the UK. All told, Bartsch and Ahya expect GDP growth to rebound modestly to 3.2% next year.

For more Morgan Stanley Research on the global economic outlook, ask your Morgan Stanley representative or Financial Advisor for the full report, "“Trapped by Low Productivity," (Aug 10, 2016). Plus, more Ideas.