Are We Heading for a Productivity Surge?

Economists argue that the economy is poised to finally reap the rewards of digital technologies

By Irving Wladawsky-Berger

“The last 15 years have been tough times for many Americans, but there are now encouraging signs of a turnaround,” wrote economists Erik Brynjolfsson and Georgios Petropoulos in The Coming Productivity Boom, a recent opinion article in the MIT Technology Review.

“Productivity growth, a key driver for higher living standards, averaged only 1.3% since 2006, less than half the rate of the previous decade. But on June 3, the U.S. Bureau of Labor Statistics reported that U.S. labor productivity increased by 5.4% in the first quarter of 2021.

What’s better, there’s reason to believe that this is not just a blip, but rather a harbinger of better times ahead: a productivity surge that will match or surpass the boom times of the 1990s.”

After growing at an average annual rate of around 2.8% between 1947 and 1973, U.S. productivity has significantly slowed, except for the Internet-driven productivity boost between 1996 and 2004. Despite the relentless advances of digital technologies over the past 15 years— from smartphones and broadband wireless to cloud computing and machine learning — productivity has only grown at an anemic 1.3%, between 2006 and 2019. Most OECD countries have seen similar slowdowns.

What accounts for this puzzling, so-called productivity paradox and when might it finally end? Over the past several years, Brynjolfsson and his various collaborators have explored this question, first at MIT where he was faculty director of the Initiative on the Digital Economy, and since 2020 at Stanford, where he’s Director of the Stanford Digital Economy Lab. Brynjolfsson discussed these alternative explanations for the paradox at a recent MIT conference.

Difficulty of measuring productivity in an increasingly digital, services-oriented economy. Most measures of economic performance used by government officials to inform their policies and decisions are based on Gross Domestic Product (GDP) But GDP is a relic of a time dominated by manufacturing, where the production of physical goods was much easier to measure. GDP is a much less reliable measure of economic output and productivity in our digital economy, where services play a much bigger role and are subject to considerably more variation in quality and value.

How do you measure the value of the explosive amounts of free goods available over the Internet, including Wikipedia articles, Facebook social interactions, Linux open source software and You Tube videos? Since all these services are free, they’re excluded from GDP measures. Furthermore, many new services we used to pay for are now also free or nearly so, including long-distance calls, news and articles, maps and music.

A 2019 research paper co-authored by Brynjolfsson introduced a novel method for measuring the value of free digital goods to consumers using online experiments. The experiments provided an estimate of the consumer surplus of a digital good, — loosely defined as the difference between the amount consumers would be willing to pay and the actual price they did pay for the digital good. The data showed that

the digital economy is contributing considerably more consumer value than we’ve realized, especially when you consider that 15 years ago many of these digital services didn’t exist or where in their infancy.

Now, they’re tightly integrated into our work and personal lives, much more so since many or our interactions have been driven online by the pandemic.

Declining innovation and productivity. Some economists contend — most prominently Northwestern University’s Robert Gordon— that our current digital technologies, advanced and exciting as they might be, aren’t as transformative as the industrial-age technologies from the period between 1870 and 1970, when we experienced high productivity growth and a rising standard of living. Gordon argues that the slow growth of the past few decades isn’t cyclical, but rather evidence that long-term economic growth may be grinding to a halt. There was little growth before 1800, and there might conceivable be little growth in the future.

However, even a technology skeptic like Gordon admits that the pandemic will likely have a positive impact on productivity— albeit a small one— as a result of the accelerated digitization and reorganization of work. In fact, Brynjolfsson and Gordon made a modest Long Bet on productivity growth in the 2020s. Brynjolfsson predicts that “private nonfarm business productivity growth will average over 1.8 percent per year from the first quarter (Q1) of 2020 to the last quarter of 2029 (Q4).” Gordon challenges that prediction, arguing that 1.8% productivity growth isn’t consistent with the historical record. Whoever loses the bet will make a $400 donation to GiveWell charities.

Time lag between technology advances and their impact on the economy. A third explanation for the productivity paradox — the one I find most compelling — is described in The Productivity J-Curve, a 2020 working paper co-authored by Brynjolfsson. According to the J-Curve paper, there’s generally been a significant time lag for a major new transformative technology to be widely embraced across economies and societies.

While technologies may advance rapidly, humans and our institutions change slowly.

The paper identifies two phases, investment and harvesting, in the life cycle of a historically transformative technology. Since these technologies are general purpose in nature, they require massive complementary investments for their full benefits to be realized, including new products, processes and business models, and the re-skilling of the workforce. Moreover, the more transformative the technology, the longer it takes to reach the harvesting phase, when it will be widely embraced by companies and industries. Translating technological advances into productivity gains requires major transformations in the strategy, organization and culture of institutions — and these take considerable time.

For example, U.S. labor productivity grew at only 1.5% between 1973 and 1995. This period of slow productivity coincided with the rapid growth in the use of IT in business, giving rise to the Solow productivity paradox, a reference to Nobel Prize MIT economist Robert Solow’s 1987 quip: “You can see the computer age everywhere but in the productivity statistics.” But, starting in the mid 1990s, U.S. labor productivity surged to over 2.5%, as fast growing Internet technologies and business process re-engineering helped to spread productivity-enhancing innovations across the economy.

Similarly, productivity growth didn’t increase until 40 years after the introduction of electric power in the early 1880s. It took until the 1920s for companies to figure out how to restructure their factories to take advantage of electric power with manufacturing innovations like the assembly line and new electric products like consumer appliances.

Brynjolfsson argues that the 2020s will be a decade of innovation and productivity, a kind-of 21st-Century Roaring Twenties, as The Economist called it in an article earlier this year. What accounts for his optimistic prediction? The Technology Review article cites three reasons why “this time around the productivity J-curve will be bigger and faster than in the past,” which he also summarized in the LongBet prediction.

  1. Technological advances, especially AI. AI has emerged as the defining technology of our era, as transformative over time as the steam engine, electricity, and IT. In the past few years, the necessary ingredients have finally come together enabling AI to accelerate the pace of discovery and boost productivity in a diverse set of areas including retailing, finance, manufacturing, energy, biotech and medicine. Cloud computing is making these AI innovations accessible to institutions of all sizes.
  2. We’re approaching the rising part of the productivity J-curve. Beyond AI, a number of scientific and technological advances are ready to transition from the investment phase of the J-Curve to the harvesting, productivity-growth phase. These include innovations like telemedicine, e-commerce, and remote work whose deployment has been accelerated by the pandemic. It also includes breakthrough innovations in renewable energy and in biomedical sciences. “In drug discovery and development, new technologies have allowed researchers to optimize the design of new drugs and predict the 3D structures of proteins. At the same time, breakthrough vaccine technology using messenger RNA has introduced a revolutionary approach that could lead to effective treatments for many other diseases.”
  3. Aggressive U.S. fiscal and monetary policies. These policies are creating greater incentives for companies to implement productivity improvements. “The recent COVID-19 relief package is likely to reduce the unemployment rate from 5.8% (in May 2021) to the historically low pre-COVID levels in the neighborhood of 4%. … Low unemployment levels drive higher wages which means firms have more incentive to harvest the potential benefits of technology to further improve productivity.”

“When you put these three factors together— the bounty of technological advances, the compressed restructuring timetable due to COVID-19, and an economy finally running at full capacity,” Brynjolfsson says that “the ingredients are in place for a productivity boom. This will not only boost living standards directly, but also frees up resources for a more ambitious policy agenda.”

This blog first appeared July 30 here.

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MIT IDE Paula Klein, Editor

MIT IDE Paula Klein, Editor

Addressing one of the most critical issues of our time: the impact of digital technology on businesses, the economy, and society.