Best-kept secret in American society

The most effective way to improve the well-being of your family and mine is to increase the productivity of our economy. This important fact is the best-kept secret in American society. Economists have known this for years – it is a mystery why they don’t shout it out, so everyone can hear.

The benefits of productivity are easy to understand. Productivity deals with the output that can be produced by a given batch of inputs. Productivity grows when we make more output with the same inputs – for example, when two workers who have been laying 1,000 feet of telephone cable in a week find a way to lay 2,000 feet a week. It grows when two lobstermen who were tending 600 traps find a way to tend 800, and the catch increases at the same rate. When we achieve more output with the same inputs, we produce more and we make it possible for consumers to consume more.

Economists believe that higher productivity normally results in higher wages and a better standard of living. Historical data make it clear that higher productivity often benefits millions of people.

Let’s focus on wages. Economists believe that higher productivity growth usually results in higher wages. Data from the U.S. Bureau of Labor Statistics bear this out. These data show that when productivity rises rapidly, then wages – technically, compensation per hour worked, after adjustment for inflation – also rise rapidly. In the years 1957-60, productivity grew at 2.7 percent a year, one of the most rapid increases in the post-World War II period. During the same period, American workers’ wages also rose 2.7 percent a year. So productivity grew rapidly, and real wages also grew rapidly.

Compare this with what happened when productivity rose slowly. During the years 1973 to 1980, productivity increased slowly, at 1.4 percent a year. During this period, workers’ hourly compensation increased, in real terms, at less than 1 percent a year, more precisely at only nine-tenths of a percent per year.

Some might think that the difference between wage increases of 2.7 percent and nine-tenths of a percent per year is not very large. In fact, the difference is huge. With annual increases of nine-tenths of 1 percent, it would require 77 years for wages to double. But with increases of 2.7 percent, they would double in only 26 years.

Think about the living standards of your children, and your children’s children, and suppose that wage earnings are their only source of income – they have no income from stocks, bonds or rent. Often, this is actually the case. Families living under the scenario of slow productivity growth would not double their incomes until 77 years had passed. With this slow growth rate, your children would not be much better off, though your great-grandchildren finally would be.

Ireland gives us a powerful illustration of the importance of rapid productivity growth. In 1970, Ireland was one of Western Europe’s poorest countries. Since then, its productivity growth rate has been 4 percent a year, about double the U.S. rate. Now its gross domestic product per person is among the highest in Europe and living standards have improved correspondingly. In 2005, Ireland’s GDP per person is running at about $35,000, only 10 percent below the U.S. level.

OK, you might say, productivity is important, but isn’t it more important to know how to raise productivity?

You’d be right. And economists have thought hard about this. Most agree that people who are well-educated, healthy and highly motivated to work are likely more productive than people who are poorly educated, unhealthy and lack motivation to work hard. Productivity growth also is fostered by a high rate of capital investment, improved technology and increased spending on the research and development that can lead to improved technologies and products.

Often capital investment, improved technology and education must improve simultaneously. Maine’s lobstering industry is much more productive than it was a generation ago, and new GPS devices, fish finders and marine sonar and radar devices are largely responsible. But these new technologies require a large capital investment, and well-educated lobstermen are needed to use them effectively.

Obviously, we need to know how to produce highly educated people, improved technologies and new and better products. Part of the answer is to give tax breaks to companies for capital investment and for corporate research and development – as we in fact do. Government investment can also play an important role. For example, government-sponsored agricultural extension programs, in the last century, and the government’s recent development of the Internet contributed mightily to our past and current economic successes.

The biggest contributions to higher productivity are probably found elsewhere, however. Surprisingly, simple features of a society may yield bigger results than actions deliberately taken to improve productivity. The key features are low inflation, balanced government budgets, the rule of law including secure property rights and the enforceability of contracts, and low crime rates, including low rates of theft, corruption and white-collar crime. Other means of encouraging productivity are high-quality education, low tax rates on individual taxpayers and policies favoring free trade.

Now you know the economists’ best-kept secret. You can use it by demanding that your political leaders focus their policy discussions on raising productivity.

Edwin Dean, a seasonal resident of Vinalhaven, writes monthly about economic issues.