Jack Beebe

Jane Haltmaier

English

Research Papers in Economics

§;r;~  if~  JF Ie  (ii\j[~\ cc Ii §)  (c CD) 
November 14,1980 
Productivity Slowdown: II 
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 
1948-65 period to 2.3 percent in 1965-73, 
and then to only 1.2 percent over the 
1973-78 period. (Total factor productivity-a 
more inclusive concept that measures the 
productivity of labor and capital combined-
displayed 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 be-
tween the 1948-65 and 1973-78 periods 
could be explained by broad-based declera-
tions in ten of the nation's twelve industry 
sectors. 
Productivity analysts have been hard at work 
attempting to pinpoint the causes of  this per-
vasive productivity slowdown. Perhaps the 
most likely candidate has been the well-
publicized 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 improve-
ments 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. 
Capital deepening and labor 
As much as 0.9 percentage points of the 
2.0 percentage-point deceleration in labor-
productivity growth between the 1948-65 
and 1973-78 periods is related to slower 
growth in capital intensity (gross capital 
stock/hours worked). Capital intensity in-
creased at a 2.8-percent annual rate over the 
1948-65 period, but slowed to rates of 2.5 
percent and 1.8 percent over the 1965-73 
and 1973-78 periods, respectively. Butthe 
deceleration generally reflected not so much 
slower growth of capital investment as more 
rapid growth of labor inputs, at lea'st until 
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 develop-
ments 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 rela-
tively inexperienced labor also helped to 
stimulate the growth of retail trade and ser-
vice industries, such as fast-food chains, 
where technology could adapt readily to the 
supply of inexperienced workers. 
This situation is now turning around. Since 
1973 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 stimu-
late future labor-productivity growth. 
Investment: macro-policies ... 
The other major factor involved in productiv-
ity growth, capital investment, is a complex 
phenomenon that normally involves large 
entrepreneurial risk over periods of years. 
Capital decisions are sensitive to the pres-
ent-and more importantly, the antici-
pated -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 
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nor of the Board of Covernors of the Federal 
Reserve Systern. 
macroeconomic (economic stabilization and 
growth) and microeC':momic (regulatory) pol-
icies of government. 
The macroeconomic climate of the 1960s 
was conducive to investment. The combina-
tion of a low inflation rate, strong economic 
growth, and the investment tax credit tended 
to lower the cost and raise the expected re-
turn of capital during that period. Hence, 
the acceleration in capital investment over 
the 1965-73 period largely reflected these 
factors. 
The 1970s represented a different story. Eco-
nomic uncertainties, inflation, and the exist-
ing tax laws undoubtedly affected both the 
level of  capital investment and specific types 
of  investments. The 1974-75 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 uncer-
tainties. Equally important, rampant inflation 
increased the effective tax burden imposed 
on capital investment during this period. 
For one reason, depreciation must be calcu-
lated for tax purposes on the basis of histor-
ical (rather than replacement) cost. With 
accelerating inflation, depreciation write-offs 
have been inadequate to cover capital re-
placement 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 invest-
ments. 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. 
. . . and micro-policies 
Government regulations-present and pro-
spective-have received much of  the blame 
2 
for the productivity slowdown, despite the 
difficulty of quantifying their effects. Regula-
tions 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 I  ations have had I  ittle effect on aggregate 
productivity growth. 
The same may not be true, however, of  the 
indirect effects of government regulations. A 
proliferation of rules for environmental pro-
tection 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 mea-
sured output-i.e., to lower productivity 
growth -because the benefits are not count-
ed 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  . 
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 energy-
usage data and evidence regarding substitut-
ability among energy, capital, and labor in-
puts. Although higher energy prices certainly 
have reduced real consumption and affected 
the design and choice of new capital equip-
ment, their effect on aggregate productivity 
growth apparently has been small to date  . 
Some economists attribute at least part of  the 
productivity slowdown to retarded spending for research and development, which has 
declined as a share of  GNP since the late 
1960s. (The research and development de-
cline came about largely because of a reduc-
tion in government defense expenditures.) 
Other analysts argue, however, thatthe link is 
weak between R&D (particularly govern-
ment-sponsored R&D) and productivity. A 
reduction in the growth of R&D spending 
may be a factor in the productivity slow-
down, but it appears to explain only a small 
portion of  the deceleration. 
Uncertain future 
Unfortunately, we are left with many poten-
tial causes of  the productivity slowdown, 
most of  which cannot be quantified accurate-
ly. A small part of  the slowdown (about 15 
percent) results from intersectoral shifts, 
while a much larger part (almost half) is re-
lated to a slower growth in capital deepening. 
That sti II leaves much of  the productivity 
slowdown urlexplained, and moreover, the 
Annual  Average 
Change(%) 
4.0 
Capital - Labor  Growth 
3.0 
2.0 
to 
Capital-labor 
ratio  "' 
1948-65 
3 
underlying causes ofthe slowdown in capital 
deepening also remain difficult to identify 
with certainty. 
Labor-force growth will slow dramatically in 
the 1980s, imparting a positive boost to cap-
ital 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 un-
certain. Much depends on whether we over-
come our recent problems, such as severe 
business cycles, a high andvariable rate of 
inflation, and increasing taxation and regula-
tions. 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.  . 
Jack Beebe and Jane Haltmaier 
Capital 
1965-73  1973-78 'J!I~:J IO:>SpU~J:I u~S 
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT 
(Dollar amounts in millions) 
Selected Assets and Liabilities 
Large Commercial Banks 
Loans (gross, adjusted) and investments* 
Loans (gross, adjusted) - total# 
Commercial and industrial 
Real estate 
Loans to individuals 
Securities loans 
U.s. Treasury securities* 
Other securities* 
Demand deposits - total# 
Demand deposits - adjusted 
Savings deposits - total 
Time deposits - total # 
Individuals, part. & corp. 
(Large negotiable CD's) 
Weekly Averages 
of Daily Figures 
Member Bank Reserve Position 
Excess Reserves (+ )/Deficiency (  - ) 
Borrowings 
Net free reserves (  + )/Net borrowed( - ) 
* Excludes trading account securities. 
#  Includes items not shown separately. 
Amount 
Outstanding 
10/29/80 
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 
Weekended 
10/29/80 
51 
132 
81 
Change 
from 
10/22/80 
271 
220 
23 
172 
56 
- 33 
9 
42 
185 
24 
- 13 
619 
451 
688 
-
-
-
-
Weekended 
10/22/80 
66 
146 
- 211 
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Change from 
year ago 
Dollar  Percent 
6,298  4.6 
7,374  6.6 
2,815  8.7 
6,902  16.4 
133  - 0.6 
533  31.6 
776  - 10.4 
300  1.9 
1,102  - 2.4 
1,703  5.4 
398  1.4 
8,799  15.5 
8,279  17.1 
4,367  21.1 
Comparable 
year-ago period 
45 
125 
80 
Editorial comments may be addressed to the editor (William Burke) or to the author . . , . Free copies of this 
and other Federal Reserve publications can be obtained by calling or writing the Public Information Section, 
Federal Reserve Bank of San Francisco, P.O, Box 7702, San Francisco 94120. Phone (415) 544-2184. 

Productivity slowdown: II

http://www.frbsf.org/publications/economics/letter/1980/el80-46.pdf

Productivity slowdown: II

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Research Papers in Economics