The Productivity Problem - Economic Research - St. Louis Fed

I HE American economy has been plagued by nu-merous economic problems during the seventies. Ofparticular importance, of course, are the relatively highinflation and unemployment rates, the changing andgrowing influence of government in individual lives,and problems associated with the dramatic rise inenergy prices. Such issues have been widely recog-nized during this decade.

One fundamental problem, however, has just re-cently begun to attract increasing attention — theslow growth of U.S. labor productivity in the seven-ties. The Joint Economic Committee in its 1979 Mid-year Report refers to lagging productivity growth asthe “Linchpin of the Eighties.”1 Likewise, a recentexamination of the major economic issues in 1979begins with five studies on the productivity problem.2

Despite the recent flurry of attention, however, thereappears to be no consensus on the source of the slow-down, its sigaficauce, its impact on the economy oreconomic policy, or the possibility or desirability ofpolicy reactions to the problem.3

Since productivity developments in the seventiesappear to be a puzzle, it is useful to examine carefullythe explanations that have been advanced in search

tSee Joint Economic Committee, Outlook 1980’s Midycar Re-port and Staff Study, U.S. Congress, 96th Cong., (August1979).

2See William Feliner, Project Director, Contemporary Eco-nomic Problems 1979, American Enterprise Institute for Pub-lic Policy Research, 1979.

of a clue.~Such an examination shows why the pro-ductivity problem has only recently been generallyrecognized and provides insight into the role ofgovernment policy in reversing the adverse produc-tivity developments of the seventies. Prior to consid-ering the various hypotheses about recent produc-tivity developments, a brief review of what is meantby productivity, the sources of its growth, and recentproductivity developments is necessary.

PRODUCTIVITY ANDITS GROWTH RATE.

Productivity is a concept which relates the output ofa production process to the inputs used in the process.There are several ways to view productivity since,in most processes, several resources are used. Onemay refer to labor productivity, which is the outputobtained per worker employed or per hour of work.Similarly, the productivity of other resources, such asphysical capital or energy, may also be of interest.A more general notion is that of total factor produc-tivity which relates output to the entire set of physi-cal resources used in the production process by as-signing a weight to each resource employed based onits relative importance in the production process.

The Produetivity ProblemJOHN A. TATOM

3F’or example, the four factors cited most frequently at a re-cent conference on productivity were a decline in capitalinvestment, a slowing in the introduction of new technology,the changing composition of the labor force toward relativelymore inexperienced groups, and an increase in service em-ployineut relative to manufacturing employment. Barry Bbs-worth, head of the President’s Council on Wage and PriceStability at the time, however, demoustrated that these ex-planations are not significant in explaining the exteut of thecorrent productivity problem. See the discussion of the con-ference by Bradley Graham, ‘Productivity Problem Outlined,”Washington Post, October 4, 1978. The article also points out

that while Robert Strauss, then special assistant to the Presi-dent on inflation and trade policy, noted at the conferencethat “Productivity is a terrible problem for this nation,” thegovernment’s National Center for Productivity and the Qualityof Working Life, an institution chartered at the beginning ofthis decade to study and promote productivity, was allowedto go out of existence in October 1978.

~Edward F. Deoisoo, “Explanations of Declining ProductivityGrowth,” Survey of Current Business (August 1979), pp.1-24, examines 17 factors which might account for the pro-ductivity dedine and finds them insufficient to explain thepuzzle. Several of the factors he considers and rejects, in-cluding, for example, the “people don’t want to work anymore” hypothesis, are not discussed here. Denison’s viewsdiffer from those presented here in that he dismisses bothenergy developments and slow growth of the capital stockas factors responsible for the decline.

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One may understand moreclearly the different views ofproductivity by consideringthe production process itself.In any production process,output is obtained by organ-izing the use of various re-sources and utilizing a giventechnology. Output may beincreased by using more re-sonrces, by improving theorganization of the produc-ing unit, or by introduc-ing an improved technology.

If more output is obtainedthrough improved organiza-

tion or technology withoutchanging the level of re-source use, total factor pro-ductivity (the output pertmit of resources employed)and the output per unit ofany single resource used willincrease.

Output may be increased, however, by simply us-ing more of a specific resource, such as labor, withoutaltering the methods of organization, the technology,or the use of other resources. In this case, the outputobtained per unit of other resources rises, so theirproductivity is higher. Whether output rises relativelymore or less than the increase in labor employmentdetermines how the productivity of labor changes.According to the “principle of diminishing returns,”the productivity of labor in such an example falls be-cause the amount of other resources used per unitof labor declines.

The analysis of productivity usually focuses onmeasures of the productivity of labor. For the firm,output per worker (or per hour) is important becauselabor costs represent a major share of the total costof production. Consequently, changes in output perworker have an important bearing on employmentand output decisions, as well as on wages and prices.Improvements in labor productivity tend to lower unitcosts of output, and provide incentives for firms toexpand production. This, in turn, tends to result inlower output prices (relative to those of other goodsand services) and/or higher wages for employees.

Labor productivity growth is also important at anaggregate level, primarily as a reflection of economic

growth. Real income in an economy is often viewedas the product of the size of the working populationand output per worker. Thus, growth in real incomeper capita is primarily determined by labor produc-tivity growth. The only other source of change ofreal income per capita — a change in the percentageof the population that is working — varies over thebusiness cycle because of fluctuations in employment,hut does not show any’ systematic tendency to in-crease,5 Moreover, gains in real income per capitafrom this source come at the expense of leisure andhome production, unlike productivity improvementswhich permit increases in both nonmarket (for ex-ample, leisure) and market income.

According to the discussion above, labor produc-

5Since World War II, the ratio of civilian employmentto the civilian noninstitutional population of age 16 and overhas reached about 58 percent at the peak of periods of eco-nomic expansion. In the recent expansion, this ratio roseslightly above 60 percent. In 1969 it was 58.0 percent,while in 1978 it was 59.4 percent. This difference givena constant level of labor productivity and population, ac-counts for about .27 percent of the average annual real GNPgrowth rate of 2.93 percent over the period. Herbert Stein,“Why Did Consumption Not Reflect the Slackening of theProductivity Trend,” American Enterprise Institute Econo-mist (June 1979), reprinted in Fellncr, Contemporary Prob-lems, pp. 13-15, has noted that much of the productivityslowdown of the seventies was compensated for by increasedparticipation in the labor force so that growth of real GNPper capita did not slow as much,

Real GNP Per WorkerI, 972 9,9k,,

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FEDERAL RESERVE RANK OF ST LOUIS SEPTEMSER 1970

tivity is improved by increasing the employment ofother resources used by workers, or by improving or-ganization or the technology used in production. Exam-ples of the sources of such changes are increases in theskill, experience, or health of svorkers; increases in theavailability or quality of resources such as physicalplant, equipment, and energy; successful research anddevelopment efforts; and the breaking down of artifi-cial barriers to the use of resources such as labor inactivities where productivity’ would be higher.

i~&B()II PRODUCTIVITY SINGE 1941/

Numerous measures of labor productivity’ in theU.S. economy can be obtained depending upon thechoice of alternative measures of aggregate outputand labor employment such as hours or the numberof workers. Charts 1 and 2 show two of these mea-sures. Chart 1 shows real CNP divided by the quar-terly average of civihan employment, while Chart 2shows output per hour in the private business sector,which excludes output originating in governmentalunits, households, nonprofit organizations, and the restof the world. In both cases, the productivity measureis shown from 1948 to the present.°

°The charts show the logarithm of productivity to indicatetrends in growth. Throughout this article, growth rates are

Productivity growth in theseventies, particularly since

1973, has been extremelysluggish. From 1948 to early1973, the trend rate ofgrowth of real GNP per

worker was 2.4 percent peryear; since then, the averageannual rate of growth hasbeen essentially zero. Thesame pattern appears inChart 2 where the trend rateof growth was 3.0 percentper year until the first quar-ter of 1973, while the recentrate has been 0.5 percent. Inboth cases, productivity de-clined sharply during 1973-74 and, despite the relativelyrapid expansion of outputand employment since 1975,

rate of productivitythegrowth has remained un-usually slow.

The difference in growth rates in the two chartsprimarily reflects a systematic decline in hours ofemployment per worker. The average annual rateof decrease in hours per worker from 1947 to thepresent, which is 0.4 percent per \‘ear, accounts foralmost all of the difference in growth rates.7

F’AC]PORS INFIJJENC1ING.

PRODUC[1VIT’Y IN THE 813VENTIES

Many explanations have been given for the disap-pointing performance of productivity in the seven-ties. While it is not possible to empirically assess therole of each factor, and while considerable disagree-ment exists about their relative importance, a discus-sion of them can provide some insight into theproblem.‘Tj~, (h~cli.ca1V:e~u,

Until recently, the consensus was that the produc-tivity problem was due to the stage of the business

measured by changes in logarithms of variables to providesynsmctry and ease of calculation. This is a standard approx-m~atiooof rates of growth.

~This trend is found by regressing quarterly hours per workerin the private business sector on a constant, the unemploy-ment rate, and a time trend for the period 1/1948-11/1979.The unemployment rate is included to account for a sig-nificant negative relationship between hours per worker andunemployment.

Output Per Hour, Private Business Sector

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cycle and was, therefore, temporary. Productivitygrowth usually slows during high-employment periodsand recessions. During recoveries, however, produc-tivity growth generally speeds up, restoring produc-tivity to the previous trend growth path (see Charts1 and 2). Unfortunately, such a recovery did not oc-cur during the recent economic expansion.

The rationale for cyclical productivity movementsis that firms practice “labor hoarding.” During reces-sion, firms are reluctant to lay off workers since theywant to avoid the relatively large rehiring costs in thesubsequent expansion. Similarly, output increases inthe early stage of expansions are readily achieved,increasing output by increasing the utilization of laborat a given employment level. Thus, cyclical variationin output is larger than that in employment.

It has also been observed that hours of employmentper worker display a cyclical pattern. Output de-clines during a downturn are achieved by reducinghours per worker rather than by simply reducing thenumber of employees. As a result, productivity meas-ured relative to employment varies over the cyclemore than output per hour. A related point oftenencountered in discussions of cyclical productivity isthat some portion of labor employment is of the over-head variety, such as management; normally, as out-put changes over the cycle, little change in overheadlabor employment occurs. As a result, productivityvaries procycically.8

Another explanation of cyclical labor productivityis simpler and, in most respects, compatible with the“labor hoarding” view. This explanation is that theuse of capital relative to labor is procycical — firmsuse relatively more capital-intensive methods as theeconomy expands and reduce capital usage relativeto labor during economic contractions. Consequently,output changes relatively more than labor employ-ment over the cycle, and labor productivity isprocycical.9

5A discussion of these arguments may be found in many text-books. For example, see Rudiger Dornbusch and StanleyFischer, Macroeconomics (New York: McGraw-Hill, Inc.,1978), pp. 348-9. They cite productivity developments in1974-75 as an illustration of such an argument.

SEPTEMBER 1979

A recent example of cyclical changes in labor pro-ductivity occurred prior to the 1970 recession. Fromthe fourth quarter of 1964 to the first quarter of1969, the economy operated under high-employmentconditions, and real GNP per worker grew at anaverage rate of 2.2 percent per year (roughly thepostwar average). During the next three quarters,productivity declined at a 1.5 percent rate, and dur-ing the four quarters of the subsequent recession,this measure of productivity declined at a 0.5 per-cent rate. In the ensuing expansion period, however,productivity initially grew faster than average. Fromthe end of 1970 (the cyclical trough) to the firstquarter of 1973, real GNP per worker expanded at a3.6 percent rate and employment was restored toessentially a high-employment rate. Thus, an averageannual rate of growth of 1.9 percent was achievedfrom the end of 1964 to early 1973, not much belowthe rate of expansion prior to the recession.

Starting from high-employment conditions early in1973, the cyclical explanation subsequently provedinadequate. Productivity declined at a 2.1 percentrate during the three quarters prior to the cyclicalpeak in the fourth quarter of 1973. During the reces-sion (IV/l973-I/1975), real CNP per worker declinedat a 3.3 percent rate. During the recovery, produc-tivity rose faster than the prior trend rate, recover-ing some of the cyclical loss, but the cyclical resur-gence of labor productivity soon abated leaving theproductivity growth path well below its prior trend.From the trough quarter (1/1975) to the secondquarter of 1979, real GNP per worker rose at onlya 1.4 percent rate, leaving the level of productivitybelow that of the first quarter of 1973.

Another major hypothesis is that the productivityproblem results from a slowing in the pace of capitalformation and/or inefficiencies in the allocation ofnew capital expenditures.

Growth of the net stock of nonresidential plant andequipment slowed after 1973, a decline that is espe-cially pronounced when related to growth in thelabor force over this period.’° Growth of the high-

ployment is taken into account. Just as increasing the use ofcapital adds to output and labor productivity on a trendbasis, cyclical variations in the mix of resources employedaccount for temporary movements in labor productivity overthe cycle. There are no unusual departures of productivityfrom the basic empirical relationship between output and thense of labor and capital resources in the U.S. economy.

10See John A. Tatom, “Energy Prices and Capital Formation:1972-77,” this Review (May 1979), pp. 2-9. Denisou “Ex-planation of Declining Productivity Growth,” p. 3, shows

~This explanation of cyclical productivity and evidence sup-porting it is presented more fully in John A. Tatom, ‘The‘Problem’ of Procyclical Real Wages and Productivity,” Jour-nal of Political Economy (February 1980), forthcoming. Thisexplanation differs from the labor-hoarding argument pri-marily because of its implications. Discussions of labor hoard-ing often appear to imply that workers are allowed to idleabout awaiting the recovery and that, consequently, outputrepresents a departure from the normal production relation-ship linking output to labor employment. Such an implica-tion is unwarranted once the cyclical pattern of resource em-

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employment net capital stock per worker has practi-cally halted when compared with the trend rate ofgrowth of 2.9 percent per year from 1950 to mid-1972.From mid-1972 to mid-1979, capital per worker grewat a 0.6 percent rate, leaving the level of capital perworker by mid-1979 about 17 percent lower than thatimplied along the 1950-72 trend. Alternately, the netcapital stock was about $200 billion (1972 prices)lower than would have existed if the previous trendrate of growth had been achieved. A 17 percent lossin capital per worker would reduce private businesssector output per hour by approximately 4.8 percent.

Distributing the 4.8 percent decline in output as-sociated with these capital formation developmentsover the seven years, however, yields a 0.7 percentdecline per year, while the growth rate of output perhour slowed from 2.8 percent from 1/1950-11/1972 to1.0 percent from mid-1972 to mid-1979. A sizeableestimate of the reduction in productivity growth dueto the slowing in capital formation has also beenmade for the nonfarm business sector during the pe-riod 1973-77.” Capital formation has played a majorrole in the stagnation of productivity growth in the1970s. Considered alone, however, it does not ap-pear to account fully for the extent of adversedevelopments.

There are reasons to believe that estimates of therole of slower capital formation may understate its ac-tual impact. First, it is likely that the net stock of fixednonresidential capital estimated by the Bureau of Eco-nomic Analysis does not adequately capture importantchanges in the capital formation process in the lastdecade.12 In particular, the sharp increase in the rel-

ative price of energy resources rendered some of thenation’s capital stock obsolete. To the extent thatestimated series do not capture these losses in normalmeasures of “discards” and depreciation, the net capi-tal stock measures lead to an overstatement of thegrowth of the net capital stock in the seventies.’3

A second difficulty with existing measures is thatsince the late 1960s, some investment in businessplant and equipment has been made for pollutionabatement purposes. Since it is questionable to whatextent, if any, such capital formation is “produc-tive” of measured output (as opposed to a cleanerenvironment), the net capital stock measures mayoverstate the growth of plant and equipment usedby workers to produce market output. Studies gen-erally have indicated, however, that pollution abate-ment investment has had little effect on the growthof the capital stock or on labor productivity.14 Ed-ward F. Denison has estimated the impact of pollu-tion abatement capital on productivity growth to bequite small; since he accounts for this reduction byreducing the trend growth of total factor produc-tivity, rather than by reducing the size of the cap-ital stock, his results are discussed below.

There are many reasons for the slow pace of capi-tal formation, Explanations usually emphasize theextent of slack in the economy’s use of existing re-sources, the diversion of funds from investment innew plant and equipment to expenditures on health,safety, clean air and water, and large federal budget

virtually no slowing in the contribution of capital per per-son employed during 1973-76. The reason for this discrep-ancy apparently is due to his method of gror~pingfactorswhich affect productivity and the cyclical differences be-tween 1948 and 1973, on the one hand, and 1973 and 1976,on the other. As Denison points out, in each of the two pe-riods capital per person employed grew at close to the samerate. Capital per hour of all persons employed slowedsharply, however, due to cyclical differences which show upelsewhere in Denison’s groupings. Corrected for cyclicaleffects, the growth of capital per worker and capital per hourshow a sharp decline in capital accumulation.

“See J. R. Norsworthy and Michael J. Harper, “The Role ofCapital Formation in the fleceut Productivity Slowdown,”Bureau of Labor Statistics, U.S. Department of Labor Work-ing Paper 87, (January 1979), Table IV. They also provideevidence refuting the claim that labor productivity growthslowed from 1965 to 1973 due to a slowing in capital stockgrowth. This claim has been made by Peter K. Clark, “Cap-ital Fom,ation and the Recent Productivity Slowdown,” TheJournal of Finance (June 1978), pp. 965-75. Such evidencemay also be seen in Chart IV in John A. Tatom, “EnergyPrices and Capital Formation,” p. 7.

l2This data is described by John C. Musgrave, “Fixed Non-residential Business and Residential Capital in the UnitedStates, 1925-75,” Survey of Current Business (April 1976),pp. 46-52, and Tatom, “Energy Prices and Capital Forma-tion,” p. 5.

t3The theory of capacity and capacity losses due to a higherrelative price for energy resourccs is discussed in Robert H.Rasche and John A. Tatom, “The Effects of the New EnergyRegime and Economic Capacity, Production, and Prices,this Review (May 1977), pp. 2-12. This article indicatesthat the bias that overstates capital stock or capacity meas-ures is likely to tmderstate capacity utilization rate measures.Thus, utilized capital measures that use a product of autilization rate and a capital stock measure are unlikely tobe biased.

14For example, Robert H. Rasche and John A. Tatom, “EnergyResources and Potential GNP,” this Review (June 1977),pp. 10-24, found no significant differences between produc-tivity estimates using capital stock adjusted and not ad-justed for pollution abatement capital, p. 15. Similarly, thegrowth rate of an adjusted capital stock series reported byPeter K. Clark, “A New Estimate of Potential GNP,” U.S.Congress, joint Economic Committee, 1-learings on the Eco-nomic Report of the President, 95th Congress, 1st sess.,January 19, 1977, pp. 39-54, is essentially the same from1968-77, when the adjustments are present, as during theperiod 1954-68, A calculation of the capital stock in marlu-facturing, with and without adjustment for pollution abate-ment capital, by Lawrence R. Forest, Jr., “Capacity Utiliza-tion: A Discussion of Concepts and Selected Analytical Ap-plications,” Measures of Capacity Utilization: Problems andl’asks, Staff Studies No. 105, Board of Governors of theFederal Reserve System, (July 1979) pp. 57-135, showsroughly a .3 percent decline in the annual rate of capitalformation due to the adjustment from 1968 to 1977. Such adifference, one of the largest observed, has negligible effectson output per hour,

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deficits which have drained funds otherwise avail-able for new capital projects.

Inflation is also an important source of reducedbusiness capital formation. First, higher rates of in-flation tend to reduce the purchasing power of fixeddollar depreciation expenses which results in lowerreal cash returns in future periods. Also, the U.S. taxsystem treats interest payments made by firms as in-come to recipients and taxes it accordingly. Wheninterest rates rise to compensate investors for thesteady loss in purchasing power of original sums lentto firms, these receipts — which are necessary to main-tain the real wealth of investors — are erroneouslytreated as income, Consequently, higher before-taxreal rates of return are required to compensate forthese taxes, further reducing incentives for firms toraise investment funds. Finally, higher inflation ratestend to increase uncertainty about the future inflationrate. Consequently, investors and firms view the cashflows expected from investment projects as riskierand are more reluctant to invest)3

This analysis reverses the traditional view of therelationship between productivity growth and infla-tion, Until the seventies, the link was considered torun from productivity to inflation, instead of frominflation, via capital formation effects, to produc-tivity growth. According to the earlier view, inflationis largely the result of labor costs growing faster thanproductivity. Consequently, inflation accelerates whenproductivity growth slows. In the long rnn, however,productivity growth detei-mines the growth of wagesrelative to prices, but the rate of advance of pricesincluding prices of labor services, is largely deter-mined by money growth. Thus, monetary policy is animportant influence not only on the rate of increaseof prices (including wages) but also, through theeffect higher inflation rates have on capital fo,-mationand trend productivity growth, on the relative rate ofadvance of wages compared with prices.

Finally, the sharp rise in the relative price of energysince 1973 has been a major factor in the reducedpace of capital formation. When the price of energyrises relatively more than the price of business out-put, firms find that the real net cash flows expectedfrom plant and equipment are smaller because ofhigher operating costs. Moreover, to the extent that theproduction of capital goods is relatively more energy-

‘5

liurton C. Malkiel, “Productivity .— the Problem Behind thelleadlioes,” I-Iarcard Business Review (May-june 1979) pp.81-91, presents evidence of higher risk premiums built intostock and bond retums during the mid-seventies, as well asa discussion of some of the other factors inhibiting capitalformation and productivity growth.

intensive than the production of other products, arise in energy prices raises the costs of capital goodsrelative to the future prices of the products thatthese capital goods eventually will produce. Takentogether, these forces create incentives to reduceenergy, plant, and equipment usage per unit of out-put, by employing less energy per unit of capital andmore labor-intensive methods of production. This ef-fect has been shown to be quite substantial in tempo-rarily reducing the growth of plant and equipment.’°

The Rate oj T~chnalogi-cal-Change

Another important factor influencing productivity isthe rate of technological progress, which conceptuallyrepresents improvements in total factor productivitynot captured in measures of factors of production. Forexample, improvements in the quality of productiveplant and equipment are not necessarily captured instandard measures of the capital stock. Also, improve-ments in organization or technology (which repre-sent additions to the nation’s capital stock) are notalways embodied in plant and equipment measures.The contribution of these factors, as well as qualita-tive changes in other physical resources, often areassessed by including a time trend in productivitystudies to capture the secular rate of productivitychange not measured by growth in the use of phys-ical resources.

Clark estimates that the trend rate of growth oftotal factor productivity in the private business sec-tor was 1.9 percent per year from 1947-66, but slowedto a 1.4 percent rate after 1966. He attributes thisreduction to a slowing in the rate at which resourceshave shifted from agriculture to nonfarm business.’7

Rasche and Tatom find that the productivity trendrate was 1.6 percent in the private business sectorfrom 1949-75; they provide some evidence supportinga smaller trend slowdown after 1966.’~

An important factor that influences the trend rateof productivity growth is the increase in the stockof knowledge accumulated through research and de-velopment outlays.’° While it is difficult to assess its

‘0

See Tatom, “Energy Prices and Capital Formation,” andEdward A. Hudson and Dale W. Jorgenson, “Energy Pricesand the U.S. Econosuy, 1972-1976,” Natural Resources Jour-nal (October 1978), pp. 877-97.

1TSee Clark, “A New Estimate of Potential GNP.”

15See Rasche and Tatom, “Energy Resources and PotentialGNP,” pp. 16, 19.

‘°John W. Kendrick, “Productivity Trends and the RecentSlowdown: Historical Perspective, Causal Factors, and Pol-

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quantitative impact on recent productivity develop-ments, it is doubtless that a major decline in the con-tribution of such outla s to productivity has occurredin the seventies. Chart 3 shows estimates of researchand development outlays (1972 prices) from 1955-78.From 1955-68, the average annual rate of growth ofsuch expenditures was 7.6 percent. From 1969 through1976, such expenditures actually were lower in realterms than in 1968. While real research and develop-ment outlays rose at a 4.2 percent rate from 1975-78,the record of the last 10 years is one of substantialreduction in research and development efforts, com-pared with 1955-68.

Denison has examined three other factors that haveadversely affected the trend rate of growth of outputper unit of input. The three factors are: increasedcosts of pollution abatement since 1967, increasedcosts for employee safety and health since 1968, and

increased business costs associated withunusually high rates of dishonesty andcrime.20 The first two of these factors,under the general category of increasedgovernment regulation, have been cited

30 by many analysts as a significant force inreducing American productivity.

‘5 Denison contends that these factors

divert real resources from the productionof measured output. He estimates the ef-

20 feet of these forces, however, by assess-ing their impact on output rather than

on measured inputs. Furthermore, hefinds that over the period 1969-75 thesefactors reduced productivity growth byan average of .26 percent per year, withpollution abatement accounting for .15

percentage points; health and safety, .07points; and dishonesty and crime, .05points. The effect of these factors is quitesmall when compared to the extent of

~° recent productivity developments.

~ Rlcin’ee;S

In the past decade, the age and sex composition ofthe labor force has changed. Many analysts haveargued that the labor force has become less exper-ienced on average, as women and young people havebecome a larger proportion of the nation’s labor force,and that this development should have a temporaryinfluence on productivity)’ As Chart 4 shows, how-ever, grosvth in the proportion of women in the laborforce has not accelerated in the seventies and, sincelate 1973, the percentage of young people in the labor

force has flattened out. If these trends have had anyeffect on productivity growth, they should have beenpositive. As the participation rate of women levels offand as younger workers mature, the composition of

20See Edward F. Denison, “Effects of Selected Changes in theInstitutional and Human Environment Upon Out

1mt Per

Unit of Input,” Survey of Current Bn.sinexs (January 1978),pp. 21-44, “The Puzzling Drop in Productivity,” Challenge(May-June 1979), pp. 60-62, and “Where Has ProductivityGone,” in William Fellner, Project Director, ContemporaryEconomic Problems 1979, pp. 71-77.

21For example, see Ceorge Perry, “Potential Output and Pro-ductivi~’.”Brooking.s Papers on Economic Activity (1:1917),pp. 11-47, and William Fellner, “The Declining Growth ofAmerican Productivity: an Introductory Note,” Contempo—wry Economic Emblems 1979, pp. 3-12.

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icy Options,” Contemporary Economic Problems 1979, pp.17-69, attaches primary importance to this factor in account-ing for the slowdown. One of his estimates is that the eon—tributioro of advancing knowledge due to formal and informalresearch and development inventiveness, and diffusion of

technology and capital goods contributed 1.4 percentto annual productivity growth in 1918-66, 1.1 percent in1966-73, and 0.8 percent irs 1973-78. Denisou and othershave shown that these estiusates are probably seriouslybiased upwards. See Deoison, “Explanations of DecliningProductivity Growth,” pp. 6-8.


the labor force will be-come relatively more ex-

perienced.22 Consequently,changes in the age structuretoward older, more experi-enced workers are expected

to have a positive effect onproductivity in the nextdecade.

Another important factorinfluencing the quality of la-bor resources and productiv-ity is the health and educa-tion of workers. In the pastdecade, there is no evidencethat the trends of rising edu-cational levels and improv-ing health of workers have

been reversed, or that thecontribution of such influ-ences to productivity havelessened.23

~

Energy price developments have provided a majorshock to the world economy in the seventies and haveaffected productivity, output, prices, and growth. Theextent of the influence on productivity, however, re-mains a matter of controversy.

Rasche and Tatom have argued that the rise in theprice of energy’ resources relative to that of businessoutput reduced the economic capacity of the busi-ness sector, raised prices of output, and reduced pro-ductivity of existing capital and labor resources.’4

These effects stem from efforts to economize onenergy in production by substituting the use of otherresources. For example, they estimate that the increasein energy costs in 1974 alone reduced labor and capi-tal productivity by about 4 percent. For the 1973-78

“2It is difficult to assess the importance of the composition ofthe labor force on productivity, For example, attempts toassess the role of the age stmcture of the labor force onoutput by including variables to control for it ii, a pro-duction function framework are often unsuccessful in thatsuch variables are not statistically significant. See Rascheand Tatom, “Energy Resources and Potential GNP,” p. 15.

‘3See, for example, Fellner’s comments on education in “TheDeclining Growth of American Productivity,” p. 8.

29See Rasche and Tatom, “The Effects of the New EnergyRegime on Econonuc Capacity, Production, and Prices,”“Energy, Resources arid Potential GNP,” and “Potential Out-put annl Its Growth Rate — The Dominance of Higher En—ergv Costs in the 1970s,” U.S. Prodoctice Capacity: Estin,at-ing the Utilization Cap ( Washington University: Center forthe Study of American Business, Decen,ber 1977), pp. 67-106.

period, higher energy prices reduced the growth rateof labor productivity by 1.3 percent per year, irrespec-tive of the indirect effects of energy costs on produc-tivity due to energy-induced reductions in capitalformation. By lowering productivity, higher energycosts led to a decline in the demand for other re-sources. This decline, in turn, was reflected in a fallin real wages and a reduction in firms’ desired capital-labor ratios. The observed decline in the capital-laborratio since 1972 can be explained almost entirely byenergy price developments alone.25

Other analysts have argued that the effect of in-creased energy prices on the economy has been muchsmaller. For example, Fellner attributes only .3 per-cent of the 1.9 percent per year decline in trend pro-ductivity growth from the 1948-73 period to the 1973-77 period to the shift of production away from energy-using methods.26 Denison points out that the timing25

See Tatom, “Energy Prices and Capital Formation,” andHudson and Jorgenson, “Energy Prices and the U.S. Eeon-sm~y. They have produced similar results for the impact ofhigher energy prices on capital formation and, consequentlyon productivity. Others have provided support for relatively’large short-run effects of changing supplies of energy as

reflected in relative prices of energy. See Clark, “A NewMeasure of Potential Output,” and Jacques It. Artos, Meas-ures of Potential Output in Manufacturing for Eight Indus-trial Countries, 1955-78,” International Monetary Funds StaffPapcrs (March 1977), pp. 1-35.

‘°See Fellner, “The Declining Growth of American Produc-tivity,” p. 6,

Women and Youth as a Percent of the Labor Force

~ ~~jfl ~ [!!i:j j]~]ji: :‘194549 59 58 525354 555657 58 59 65 68 61636465666768697871737374757677728979

S—l]l—~l.S.5,p,,t—’11~iL1b~’

l’b~’9—t”—5’i1.2411tl”1

Page 10

FEDERAL RESERVE SANK OF ST LOUIS SEPTEMBER 1979

used per unit of output

3—

chart 5

Industrial Sector Ratio of Energy to Output

I1960 61 62 63 64 65 66 61 68 69 70 11 72 73 74 15 76 77 18 1979

Source: U.S. Department of Energy and US. Department of commerce‘Ratia of e, e~gyto real industrial GNP The industrial secta, is cam posed ai ca,structian. manufacturing,

agriculture, and mining.Safest data platted: 8977

of energy price developments coincides with that ofthe adverse productivity developments. Nevertheless,he insists that a more reasonable estimate of the effectof higher energy prices on productivity is 0.2 percentfor the period 1973-76, the upper bound of the sizeof the effect as discussed by Perry.27

Both Perry and DeLeeuw have argued that forproductivity to have been adversely affected by energyprice developments, a siguificant decline in energy

2TSee Denison, “Where Has Productivity Gone?” p. 76, “ThePuzzling Drop in Productivity,” p. 62, and “Explanationsof Declining Productivity Growth,” pp. 15-18 and GeorgeL. Perry, “Potential Omttput : Recent Issues anrl Pl’esentTrends,” in U.S. Prodoctice Capacity: Estimating the Util-ization Gap, pp. 6-12.

Thousands of flU’sPer Dollar of Real Industrial GNP63

Annual Data

62

61

60

59

58

57

56

5~

LA

would have had to occur.28

Likewise, both have notedThousands of flU’s that the reductions in en-

Per Dollar of Real industrial ClIP63 ergy use that followed the

sham-p rise in energy pricesin 1973-74 were quite small,although both also have ac-knowledged the diffIculty of

61 obtaining meaningful dataon energy used by business.

Perry claims that energyused per unit of output in

59 the business sector declined10.2 percent from 1973 to

58 1976, while the trend in suchreductions from the pastalone would have generateda 5.3 to 7.3 percent reduc-tion in energy usage. Thus,

56 he claims that energy pricedevelopments reduced en-ergy use by only 2.9 to 4.9

percent over this period.Similarly, DeLeeuw, citingratios of total and industrialenergy consumption to totaland industrial real GNPwhich show a downward

trend from 1970-73, argues52 that this negative trend did

not accelerate after 1973.

53

Chart 5 shows the ratio of industrial energy use (E)to “industrial” real GNP, where the latter is the realGNP originating in manufacturing, construction, agri-culture, and mining sectors for the period 1960~77.29

This ratio declined after 1970, as DeLeeuw and Perrypoint out. There is no apparent trend in this ratio,however, over the longer period 1960-72. A simpleregression of the logarithm (ln) of this ratio over theperiod 1960-72 fails to reveal a significant negativetime trend when the effects of changes in the rela-

25See Frank DeLeeu~v, “Comments on Rasche and Tatom,” inU.S. Productive Capacity: Estimating tine Utilizations Gap,pp. 137-45.

‘°The energy data is taken from U.S. Deparlment of Energy,Federal Energy Data System (FEDS) Statistical Smnosroanj.This data series is available from 1960-77.

Page 11

five price of energy and cyc-lical variations in the ratioare taken into account.

The estimated equation,together with one that omitsthe time trend, is shown inTable 1. The price of energy,

Pe, is measured using theproducer price index forfuel, related products, andpower deflated by the [in-plicit price deflator for pri-vate business sector output.The cyclical adjustment var-iable, UN, is the differencebetween the unemploymentrate of the civilian labor

force and a measure ofthe unemployment rateunder high-employmentconditions.3°

The most notable features of these estimates arethe size and significance of the relative price coeffi-cient which indicate that the energy ratio is con-siderably more sensitive to prices than either Perryor DeLeeuw believe. In addition, the statistically

Tab e I

The st 1 I Ene gy Ratio960721

in ( /RtSNP) 7634 207 Irs P 0043U 0005(340) 270) (4.231 094)

P2 072 OW 150

SE 002

In (S/P P) — 5.701 0~25 fri P + 0039 U(634) ( 441) (422)

P’ 069 OW —~1315 0025

30The full-employment unemployment rate is that prepared byPeter K. Clark, “Potential Output in the United States 1948-1980,” U.S. Productive Capacity, Perry uses the ratio of realGNP to Isis estimate of potential real GNP which is highlycorrelated with such a measure of excessive unemployment.It should be noted that w’heu the equations in Table 1 areestimated with the Cochrnne-Oreutt technique, the auto-correlation coefficient is not significant. Thus, autocorrelationcan be rejected.

significant positive coefficient on the excess unemploy-ment rate suggests that the failure of the energy ratioto decline more substantially after 1973 is partly dueto the unusually high levels of unemployment in1975-77. Apparently, energy usage contains a signifi-cant overhead component that is insensitive to cyclicalvariation in output. This contrasts sharply with Peny’snegative cyclical coefficient.31 Finally, since the timetrend is insignificant, assessing energy reductions rela-tive to a negative trend understates the extent ofenergy reductions after 1973.32

5tThe cyclical sensitivity of the energy ratio is essentially anempirical question since one could argue that over the cyclesome firms, such as utilities and metal producers, are ableto meet temporarily high den3and using less efficient (espe-cially with regard to energy use) plant and/or equipment,and this capital, in turn, is the first to be laid off duringrecessionary sales periods. If this effect dominated the useof overhead energy, the energy ratio would be reduced byslack in the economy. On the other hand, the energy pro-ducing sector is the most energy intensive production sector,Given the rise in the relative price of their products due toreductions in the availability of other energy sources, somefirms would temporarily have an incentive to expand theuse of plant and eqnnipment that would otherwise have beenobsolete. This effect would raise the energy ratio during therecent slack period.

32The White house, Fact Sheet on the President’s Program,reprinted in Daily Report for Executives, (April 5. 1979),supplement p. 4, points out that industrial energy use hasdropped by 6 percent while output increased 12 percesstsince 1973. This represents a drop in the ratio of about 18pereenst.


chc:, u

Output Per Hour in Manufacturing

8948 49 50 95 52 53 54 55 56 57 58 59 60 60 62 62 64 65 66 67 68 69 70 75 72 73 74 75 70 77 705979

Page 12

Tabin 2

Production Funcflons fro Manufacturing

and The Private Business Sector

1948-1976)

X.. .426 . 0524 in h 0476 ink. 0128 In?,. - C~2t14 10) 12.48) (2 25) I 2.171

~: 0.93 OW 159SE. 0021 083

is, X i54~ 0/15th 0.285 Ink 0.iC’9 in ‘ C.OItt112 345 ( 3 95) 5 ~5 5.16) (10475

0 C.98 DW 536S.E 0009 I’ 0.59

SEPTEMBER 1979

well. In fact, the evidence from the manufacturingsector supports this explanation.

Productivity growth in the manufacturing sector hasslowed relative to its past trend (see Chart 6). From1948 to 1973, manufacturing sector output grew at anaverage annual rate of 3.8 percent, while hours grewat a 1.0 percent rate. From 1973 to 1978, manufac-turing output growth slowed to a 1.7 percent rateand hours growth declined at a 0.1 percent rate. Con-sequently, output per hour in manufacturing slowedfrom a 2.8 percent rate of growth to a 1.6 percentrate. Comparable figures for the private business sec-I~orshow a decline in growth of output per hour froma 2.9 percent to a 1.0 percent rate. While the declinein the growth rate in manufacturing is smaller, this


Estimates such as those in Table 1 should be viewedskeptically, however. First, as Perry and DeLeeuwpoint out, the data are problematical.°3 Second, thedata cover only direct energy purchases and not theenergy component of intermediate products purchasedfrom other industries including transportation. Third,the energy measure is in Btu equivalents rather thanan index of the quantity of energy which is compati-ble with the producer price index for energy.

Most important, however, the size of the price ef-fects on the energy-output ratio is unimportant tothe hypothesis that relates energy price developmentsto the sharp decline in productivity in 1974 and itssubsequent slow growth. The Rasche-Tatom estimatesof the effect of the relative price of energy resourceson productivity apparentlyare not biased by implicitassumptions about energydemand. If the assumptionsintroduced such biases, theywould be detected in othercoefficients of the model esti-mated. In this regard, it iscurious to note that, if en-ergy use is less price sensi-tive than the approximationused by Rasche and Tatomimplies, their estimate of theenergy and energy priceelasticity of output would betoo small, not too large.°4

Thus, the claim of a lowprice elasticity of demand for energy made by Perry,DeLeeuw, and Denison would reinforce the Rasche-Tatom conclusions if it were correct.

In a related fashion, some have argued that produc-tivity developments in the manufacturing sector havenot been unusual.35 If increased energy prices are animportant causal factor in the productivity decline,they should produce a slowing in manufacturing as

33For example, the regressions end in 1972 because the indus-trial sector energy use data in the U.S. Department of Energy,Monthly Energy Review, reported since 1973, show a lowerlevel of energy use in 1973. The more recent data also showthat energy use declines much more rapidly from 1973-78than in the Federal Energy Data System estimates.

34See Rasche and Tatom, “Energy Resources and PotentialGNP, Appendix II, p. 23. Denison, “Explanations of De-clining Productivity Growth,” pp. 16-17, criticizes the pricesensitivity assusnptinu while arguing that the energy priceelasticity of output must be smaller than Rasche and Tatomestimate.

355ee, for example, “Behind the Slump in Productivity

Morgan Guaranty Survey (November 1978), pp.

does not imply that the energy price effect observedfor the private business sector was smaller or absentin manufacturing.

An estimate of the Rasche-Tatom production func-tion for manufacturing shows that the energy effecton manufacturing is essentially the same as that forthe private business sector.36 Table 2 shows estimatesof PBS output (X) and manufacturing output (X~)for the period 1948-76. In each case, output is a func-tion of hours employed (h), the product of the sec-tor’s lagged net capital stock and the Federal ReserveBoard capacity utilization rate (k), and the relativeprice of energy in each sector (P.), which is foundby deflating the producer price index for fuel andrelated products and power by the implicit price de-flator for output in the respective sectors. There islittle difference between the size of the effect of therelative price of energy on the private business sector

36The theory and deviation of the equations estimated arediscussed more fully by Rasche and Tatom, “Energy Re-sources and Potential GNP.”

Page 13


or on manufacturing output. Furthermore, the effectis statistically significant at conventional levels in eachcase.37 The smaller decline in productivity growth inmanufacturing apparently results from the fact that,while the growth of the net capital stock in manu-facturing slowed after 1973, it grew faster than hoursemployed. Growth in the capital stock per hourof all persons employed slowed for the privatebusiness sector during 1973-78, but accelerated inmanufacturing.35

The rise in the relative price of energy was largelydue to OPEC actions since 1972; the relative price ofenergy rose by a similar amount on a worldwide scale,except to the extent that various nations may haveoffset the increases by lowering their specific taxeson energy products. Consequently, if the energy price-productivity hypothesis is correct, one would expectto observe adverse productivity developments andslower capital accumulation in other nations.

Table 3 shows the trend growth rate for 11 indus-trial countries from 1960-73 and the average annualgrowth rate for each country from 1973-78, exceptfor the Netherlands and Belgium where growth ratesare computed through 1977. In each country, produc-tivity growth declined in the later period. In half theforeign countries, the reduction in the five-year aver-age annual rate was more than the standard error ofthe prior trend-adjusted annual growth rate (Canada,Sweden, United Kingdom, Italy, and Japan). In Italyand Sweden, the reduction was more than twice thestandard error of the prior annual growth rate. Thepattern of the reduction also conforms to the U.S.experience. In every country but West Germany, pro-

37The estimate of the energy elasticity of output from the equa-tions in Table 2 is 11.4 percent in the manufacturing sectorand 9.9 percent for the private business sector. Denison’sclaim that this elasticity must be larger in manufacturingappears to be correct. The difference is not statisticallysignificant, however, since the standard error for the marhu-facturing elasticity is 5.2 percent, while that for the privatebusiness sector is 1.9 percent. See Denison, “Explanationsof Declining Productivity Growth,’ pp. 16-17. The coeffi-cient on hours in the manufacturing sector is low, giventhat the share of labor cost for the manufacturing sectorduring the sample period averaged 6~.9percent. The impliedhours elasticity of output in Table 3 for manufacturing isonly 46.5 percent, but given its standard error of 18.7 per-cent, the hypothesis that the hours elasticity and laborshare are equal cannot be rejected at the 95 percent confi-dence level. When the equations in Table 3 are estimatedwith the output elasticity of hours constrained to equal theaverage sh~res of labor cost during the sample period, theestn3sate of the energy elasticity of output is 9.9 percent inboth sectors and significant. Moreover, an F-test of this con-straint fails to reject it at the 5 perceat significance level.

35When a second time trend is included in the equations inTable 2 to allow for the slowing in the rate of technologicalchange after 1966 discussed earlier, it is not statisticallysignificant at the 20 percent significance level in either case.

SEPTEMBER 1979

Table 3

Productivoty Growth Rates for 11 Industrial Nations(Output per hour)

Annual Growth Averag AnnualTrend Growth Rate

1960 73 1973 78 Difference

United States 28 % 1.7%(281%

Selgoun, 7.0 6.4 0 6(3.5)

Canada 4 4 2.5 1 9(1.2)

Denmark 7-2 4 6 2,6(2.8)

Netherlands 76 48 • 28(321

Sweden 6 7 I S SiIii)

Unoted Kingdom 4 0 0 2 3 8(20)

France £9 47 1,2(IS)

We tGermany 54 50 0.4(1.3)

Italy 66 26 40(13)

Japan 99 3.5 64(40)

(Figures in pareathe ar tanria C er or of annu I gr tIm rate

ate adautrnnttortrend)

Crow I, at 1973 7 Data to 1978 are a astabie a ths t me

SOURCE U S Department ot Labor

ductivity growth was more than one standard en’orbelow the prior trend during 1974 or 1975. In 8 ofthe 11 countries productivit~growth in 1974 or 1975declined by more than twice the standard error of the1960-73 trend-adjusted growth iatc (the exceptionsare West Germmy, the Netherlands and Denmark) ~°

Th wos’ldwide decline in prodoictisity growth has also beennoted recently in ‘Whateve Happened to P oductivity?”The Leo, ornist ( \ugust 25-31 19e9) pp. 60-61. As in thecase of manufacturing abos e it i ~0 sible that the laborproductivity decline has been partially a’o’ded in countr’esucb a’ We t Germa and Belgium by in titutional arrange-ments such a ‘indexing’ which keep real wages from fall-in and lead to fa ter capital gsos th relatise to employment.Such growth is manife ted primarily b negathe or low employment g o’~th.

Page 14


Finally, the rise in the relative price of energy ledto incentives to reduce the desired capital-labor ratioin production through a reduced pace of capital for-mation. Again, this would be expected to occur world-wide. A recent report by the Bank for InternationalSettlements shows that for the United States and fiveof the foreign countries in Table 3, real nonresidentialfixed investment slowed dramatically after 1973 com-pared with a 1955-73 trend. In the five foreign countries,such investment was virtually fiat from 1973 to 1978,compared with annual trend rates prior to 1973 of15.5 percent in Japan, 5.3 percent in Italy, 6.5 percentin Germany, 7.9 percent in France, and 5.8 percentin the United Kingdom.4° Capital formation patternsare similar in the other five foreign nations.45 In Bel-gium, real nonresidential capital formation slowedfrom a 5.2 percent average annual rate of growth in1965-73 to a 0.3 percent rate in 1973-76. Comparableslowings occurred in Denmark, (4.7 percent to —1.0percent) and the Netherlands (4.5 percent to —2.3percent). Data available through 1978 indicate thatreal nonresidential gross capital formation slowed inSweden from a 3.6 percent rate in 1965-73 to a —1.3percent rate in 1973-78. In Canada the slowingwas smaller: from a 4.6 percent rate in 1965-73 to a3.1 percent rate in 1973-78. Thus, two of the majorimplications of the energy price rise in the seventiesappear to be borne out in other nations as well.

S ~ MN.TE) (.~.X).Nc:i SIGNProductivity growth declined substantially during

the seventies. Many analysts, regarding the declineas a cyclical phenomenon which reflected unusuallyhigh levels of unemployment, did not recognize theseriousness of the problem. In recent months, how-ever, it has become more widely recognized that theproductivity problem of the seventies is not a tempo-rary cyclical aberration. Nonetheless, the source ofthe productivity problem remains controversial.

Economic theory suggests several sources of theproblem. With the possible exception of energyprice developments during the decade, however,

40See Bank for International Settlements, Forty-Ninth AnnualReport (BasIc, June 1979), p. 28. The United States showsthe most favorable growth of real nonresidential fixed in-vestment relative to the prior trend when compared withthe five other nations. I am indebted to Allan H. Meltzerfor calling my attention to this dramatic evidence.

~~The data used for these countries is fixed capital formationless residential construction, both in 1970 prices, from theOEGD, National Accounts of OEGD Gountries, Vol. II,1976. For the 1973-78 period, the data (in 1975 prices) forSwerlen and Canada is from the OECD, Quarterly NationalAccounts Bulletin, 1978/IV and 1979/I issues.

no single factor appears to account for the entireproblem. While the changing composition of the laborforce has been erroneously tagged as the main factoradversely affecting productivity in the seventies, therelatively slow pace of capital formation, includingresearch arid development capital, has quietly playedan important role in productivity’s decline, In addi-tion, the diversion of capital formation from market-oriented production to government-regulated goals(such as clean air, occupational health and safety)has been a contributing factor.

The reasons for the slowing of capital formationare as diverse as those that acconnt for productivitydevelopments. Both the increased relative cost of pur-chasing new plant and equipment and the higherrelative cost of operating capital account for a largepart of the slowing. These, in tuxn, are largely due toenergy price developments. Inflation and uncertaintyabout future inflation have also provided strongdisincentives for business investment, Much of thedisincentive effect of inflation arises through thetax system, but high inflation rates also increase thevariability of inflation, which adds to the riskiness ofbusiness ventures. Coupled svith increased risk aris-ing from growing government influence in the market-place, risk premiums built into the costs of fundshave escalated, further reducing capital formationincentives.

The influence of some of the factors affecting pro-ductivity in the seventies may be reversed in theeighties. For example, the sharp acceleration of govern-ment regulation in the seventies, to the extent it rep-resented substantial “start-up” requirements of newprograms, may slow in the coming decade. The laborforce will tend to become more experienced in theeighties as the proportio-i of young svorkers declinesand participation rates of women level off. Barringfurther disruptions, large increases in the relativeprice of energy are less likely since pricing decisionsof OPEC appear to be based upon major changesin market structure such as the formation of the car-tel or production policy changes in member countries.In addition, such increases will become increasinglylimited by the competitive cost of alternative sourcesof energy. In spite of such favorable possibilities,however, other adverse factors influencing both capi-tal formation and productivity growth remain. More-over, the substantial losses of productivity in theseventies are not likely’ to be recouped without con-siderable effort.

The list of possible policy options to restore produc-tivity growth is quite long. Essentially it includes any

Page 15


efforts that increase incentives to improve labor skills,increase the quantity and quality of plant, equipment,research and development, and increase incentives toproduce and utilize energy resources efficiently’. Mostof the proposals involve cutting various taxes or re-moving regulatory restraints to stimulate the supplyof resources and output in the economy’.

Monetary policy’ can also be useful in the promotionof productivity’ growth. Inflation and its variability re-

SEPTEMBER 1979

tard the expected returns from investment andincrease risk. Since inflation depends principally uponthe rate of growth of the money suppl~’,a policywhich obtains lower and more stable growth rates ofthe money stock would enhance productivity growth.The most practical means for removing variability ofmonetary growth and achieving a lower targetedrate of growth is to conduct policy to achievetargets for the monetary base rather than targetsfor interest rates.

N

//

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The Productivity Problem - Economic Research - St. Louis Fed