Higher productivity creates opportunity

Posted: Sep 30, 2003 12:00 AM

The slow pace of job creation is clearly the most serious political and economic problem in the country today. Although Democrats and the press continue to focus on Iraq, President Bush and congressional Republicans know that the sluggish economy is a far greater threat to their re-election than anything going on in the Middle East.

Unfortunately, there really is not much of anything Congress or the White House can do at this date that will significantly affect the economy before Election Day. Taxes have already been cut twice, government spending for defense and unemployment compensation is pumping money into the economy, and the Federal Reserve has dropped interest rates to historical lows. There simply isn't anything else that realistically can be done. And even if there were, given the time it takes for policy changes to impact on the economy, anything that was done today would likely not register until after the election.

Ironically, the biggest barrier to job growth is something economists normally applaud: high productivity. In the second quarter of this year, output per hour in the nonfarm business sector was up 6.8 percent. In 2002, productivity increased 5.4 percent. These numbers are twice or more than the historical trend.

When productivity is high, it means that producers are able to increase their output without having to hire more workers. Given the high overhead costs for hiring workers in today's economy, companies have been substituting computers and machines for people. This allows the remaining workers to be well paid, but reduces the demand for labor. People now worry that this trend will continue, and fewer and fewer workers will be required to produce what is needed, with the result that unemployment will stay high indefinitely.

This is not a new concern. Economists have been worrying about it for more than 200 years. Although it remains a theoretical problem that economists continue to wrestle with, experience shows that it is not a concern. Higher productivity, whether resulting from mechanization, automation or managerial improvements, has always led to more employment, not less.

Adam Smith was first to draw attention to the employment effects of productivity increases. In "The Wealth of Nations," he tells his famous story of the pin makers. Smith noted that pins were very expensive in those days and had to be manufactured by hand. So laborious was the process that one man could barely manufacture one pin per day working by himself.

But Smith observed that when a group of pin makers got together and divided their labor, they could greatly increase their output. Instead of one worker performing all the tasks -- drawing out the wire, cutting it, shaping it, sharpening it, etc. -- each worker concentrated on just a single task. Smith found that by specializing, a group of 10 pin makers were able to produce 48,000 pins per day, whereas they could produce just 10 the old way.

In the first instance, these 10 workers could probably satisfy all of England's pin needs by themselves, thus putting all the rest of the country's pin makers out of work. But with a 4,800-fold increase in productivity, the cost of pins fell dramatically. Instead of being available only to the wealthy, they became something everyone could use. This led to new uses for pins and an increase in demand for them. The second order effect, therefore, was to raise employment in pin manufacturing.

Over the years, many economists have looked at the impact of machinery and productivity on employment. Some, like David Ricardo and Karl Marx, were very pessimistic about the long-term effects. Others, like Nobel Prize winners John Hicks and Herbert Simon, are much more optimistic. Most economists probably believe that even if there is a long-term trend toward reducing employment due to automation, it can be offset by an expansionary fiscal policy.

In any case, there has never been any evidence in the data or historical experience to indicate that high productivity depresses job growth. In fact, job growth is strongly correlated with productivity growth. That is, increased productivity leads to higher production and increased employment opportunities, rather than the reverse.

The reason is that output-increasing innovations always lead to new possibilities. As historian Daniel Boorstin once put it, "People said the telephone would replace the mails, the radio would replace the telegraph, the TV would replace the radio. But what new technology does is discover unexpected roles for the old."

In the years since Boorstin made that comment, we have seen the rise of the Internet. Now, although I receive 100 or more emails per day, there has been no reduction in the amount of ordinary mail I get. I just get one on top of the other. In practice, the Internet has created far more jobs than it displaced. That same is true for other productivity-enhancing innovations, as well.