When the tectonic plates of the world economy shift, attention focuses on the most noticeable signs, such as China’s rise. But, as in geology, much change in long-term economic performance is harder to spot.
One such change may be productivity growth on either side of the Atlantic. The capacity to increase output per worker is the key determinant of long-term economic welfare. Unfortunately, measuring productivity, let alone predicting its dynamics, remains controversial.
You can see the computer age everywhere but in the productivity statistics, declared Nobel laureate Robert Solow in 1987. Information technology has since become ubiquitous, not least in US economic statistics. Techniques pioneered to capture quality improvements in IT have proliferated. As Pimco, the bond fund, points out, such hedonic inflation adjustments now cover a wide range of goods, accounting for almost half the weight of the US consumer price index including even college textbooks.
Measurement issues have clearly contributed to the transatlantic productivity gap. Until the mid 1990s, Europe was catching up, before seeing productivity increases slow to a snail’s pace. In contrast, most now expect 2.5 per cent annual US productivity growth, arguing that in a deregulated economy IT is proving as significant as the diffusion of electricity once was. But the rise of IT has also been helped by the availability of easy money, while services now account for 68 per cent of US gross domestic product. In many personal services, productivity is notoriously hard to increase, suggesting scope for setbacks. If US productivity growth slowed by 1 percentage point, equity valuations should, ceteris paribus, fall by 40 per cent.
Simultaneously, eurozone productivity growth has accelerated to 2 per cent since the second quarter of 2003. That trend may reverse, but Europeans, too, could become better at using computers. Productivity trends may yet emerge as another reason for European equities to continue their surprising long-term outperformance of their US peers in dollar terms.