Productivity has increased, along with hopes that this will stimulate the economy

The last time the U.S. economy posted surprising economic growth rates amid rapid wage increases and moderating inflation, Ace of Base and All-4-One topped the Billboard charts and denim overalls were in vogue.

Thirty years ago, Federal Reserve officials hotly debated whether the economy could continue to move so strongly without causing a rise in inflation. And in 1994 it turned out that this was possible, thanks to one key ingredient: productivity.

Now official productivity data shows a major improvement for the first time in years. Data has been volatile since the start of the pandemic, but with the dawn of new technologies like artificial intelligence and the embrace of hybrid work setups, some economists are questioning whether the recent gains can be real — and whether they can turn into lasting growth . tree.

If the answer is yes, it would have enormous consequences for the American economy. Improved productivity would mean that companies could create more products per employee. And a steady increase in productivity could get the economy off to a healthy start. More productive companies are able to pay better wages without having to raise prices or sacrifice profits.

Several trends happening today show parallels to what happened in 1994 – but the differences explain why many economists are not yet ready to announce a turning point.

The computer age versus the zoom age

By the end of the 1980s, computers had been around for decades, but had not yet delivered major productivity gains – what has become known as the productivity paradox. Economist Robert Solow said in 1987, “You can see the computer age everywhere except in productivity statistics.”

That changed in the mid-1990s, when semiconductor production improved and computers became cheaper. Companies began to learn how to invest in information technology, and it helped boost productivity tremendously.

Economists and analysts have been for years have questioned whether we might be facing a new productivity paradox: despite our sudden access to cloud computing, high-speed Internet connections and mobile phones, productivity gains were tepid in the late 2000s and throughout the 2010s.

Since 2020, companies have learned how to leverage existing digital tools in new ways as employees transition to remote work. Will this lead to lasting efficiency improvements in some sectors?

Until now, there is still a lot of debate about whether remote work is good or bad for productivity a recent article explained by Nicholas Bloom at Stanford and other researchers. Early research has suggested that employees may be less efficient when working completely remotely, and that hybrid work leads to little or no productivity gains.

But workers who save time on commuting and care often feel more productive – even if that saved time isn't captured in official productivity data.

“The studies probably underestimate the effect,” Mr Bloom said, explaining that workers who are happier thanks to the flexibility of their work are less likely to quit – allowing companies to avoid unproductive retraining. Remote work could also allow companies to move more “tedious” jobs abroad, he thinks, pushing Americans toward more dynamic work.

“The overall story is potentially quite powerful,” he said in an interview, predicting that remote work is halfway to unleashing a decade-long productivity boom. “We are in a brave new world: it will take years.”

The internet versus artificial intelligence

In the 1990s, the World Wide Web came into widespread use. Companies were initially concerned that this could sidetrack their employees. (“Oh, what a complicated web, this Internet,” sighed a 1995 article in The New York Times about online distractions.) But the tools ultimately streamlined many types of work.

A retrospective During the boom of the 1990s, it emerged that a combination of efficient computer production and increased use of information technology was responsible for about two-thirds of the productivity increase during that time.

Today's shiny new technology equivalent is artificial intelligence. While many economists said it was probably too early to fully realize the benefits of AI, some proponents think it could be transformative by automating mental tasks, including writing proposals and emails.

“There's a lot more to come as more people adopt these things,” says Erik Brynjolfsson, an economist at Stanford, who is optimistic that we may be on the cusp of a productivity surge as white-collar workers have their day-to-day capabilities. supplemented with the new tools. He is running experiments and the discovery that AI helps employees, and has done so co-founder of a company that coaches companies on how to best use the technology.

But Robert Gordon, a leading productivity-oriented economist at Northwestern University, is skeptical. He said that unlike the computer and early internet era, AI's biggest impact may be on office work – while computer manufacturing also became more efficient in the 1990s, enabling profits across sectors.

“I don't see the universality of AI sweeping through the economy with such an impact across multiple sectors,” Mr Gordon said.

Walmart vs. Internet Shopping

Another driving force behind the productivity growth of the 1990s? Companies made major logistical improvements. Walmart grew quickly during the decade, which involved strong supply chain management, allowing it to efficiently stock shelves with low-cost products from around the world. Production, especially in the pharmaceutical sector, also improved.

One potential challenge is that such gains may be difficult to achieve twice: as companies have become more efficient, it may be difficult for them to improve dramatically. For example, online shopping continued to revolutionize retail in the 2010s, but both industry and in general Productivity gains were modest.

That underlines an important point about productivity growth. It's easy to pick low-hanging fruit, such as optimizing supply chains using software. Once that happens, it can become more difficult to make a profit. The economy ultimately leads to higher productivity levels, but not necessarily to sustainable high productivity growth.

Entrepreneurship is flourishing

What can lead to lasting productivity gains is a burst of innovation that feeds on itself – and that makes the recent uptick in business formation a hopeful sign. New companies are often more resourceful.

In 1994, many companies were founded as people tried to take advantage of breakthroughs in information technology. Nowadays, business applications do been rising againlikely the result of people deciding to strike out on their own after losing or quitting their jobs during the pandemic.

The new business bump could simply be a reflection of people shifting to working from home, recent research by Fed economist Ryan Decker and John Haltiwanger of the University of Maryland. But many of the new businesses are in potentially productivity-enhancing areas, including online retailing, software publishing, computer systems design, and research and development services.

Two inflation drops

The 1990s and 1920s share another potential productivity enhancer: declining pricing power.

Had inflation has been cooling down for years In the mid-1990s, Fed officials noted at their meetings that companies were losing their ability to continue raising prices without losing customers. To prevent profits from collapsing, companies had to figure out how to be more efficient.

“Out of necessity, we will tend to increase productivity because it is being forced on the system,” said Alan Greenspan, then Fed chairman. theorized at a Fed meeting.

Inflation is also falling today. And the job market was strong then and remains so today – meaning companies had to pay to attract workers. When wages rise faster than prices, companies must challenge their workers further if they hope to maintain profits.

Alan Greenspan vs. Jerome H. Powell

In 1996, Mr. Greenspan became convinced that productivity was rising – so he convinced his colleagues that they did not need to try to slow the economy so much. With productivity improving, strong growth was less likely to lead to inflation.

Jerome H. Powell, the current Fed chairman, has praised Mr. Greenspan's “steadfastness” and foresight in navigating that period.

It could be a lesson he can learn from in the coming months. Growth remains stronger than Fed officials expected, and policymakers will have to decide whether to respond by keeping rates high for longer.

For now, Mr. Powell is not convinced that America is in a new wave of productivity. “My guess is that maybe we'll shake things up and be back where we were,” he said during a Jan. 31 news conference.

But he acknowledged: “I don't know.”

In the 1990s, it wasn't until 1999 that economists really believed that productivity had taken off, noted John Fernald, an economist at INSEAD Business School. So while hope may be on the horizon now, confidence may be years away.