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The economic "disease" eating away at the U.S.

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It's no secret that productivity -- an essential driver for economic growth -- has weakened in recent years in the U.S. and around the world. Less evident is what, if anything, can be done about it.

"Productivity isn't everything, but in the long run it is almost everything," Nobel Laureate economist Paul Krugman wrote in "The Age of Diminishing Expectations." "A country's ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker."

It is likely no coincidence, at a time of diminishing standards of living for millions of Americans, that the country's productivity (defined in textbooks as worker output per hour of labor) is decreasing. Recent data suggest that pattern is likely to continue for some time.

Over the first three months of the year, productivity increased 0.6 percent. That's below the 1.1 percent rate of growth since the end of the recession, and far below the 2.3 percent average rate of growth from 1990 to the onset of the Great Recession.

What does seem to be a secret is how to fix the problem, while some economists don't believe it can be fixed at all. Robert Gordon of Northwestern University argues that the really good ideas, the ones that make a large difference to productivity, have already been discovered. According to Gordon, there have been three industrial revolutions. The first was 1750 to 1830, when inventions like steam power and railroads were discovered. The second, from 1870 to 1900, brought us electricity, the internal combustion engine, running water, indoor toilets, communications, entertainment, chemicals, and petroleum.

In his view, we are now experiencing the third industrial revolution, which has added computers, the web and mobile phones. But all such eras of innovation aren't created equal. Gordon argues that this latest revolution, which began in 1960, will not energize productivity to the same extent as revolutions past. He also contends that the current period has mostly run its course, hence the declining productivity growth to a lower "new normal" that we are experiencing.

Not everyone shares this view. Some economists believe the digital revolution has increased productivity far more than the official numbers reveal. The arguments is that many of the services enabled by digital technology, such as the apps on your phone, sell at zero price (or very nearly so). Since goods and services with a zero price do not get counted in the official GDP statistics, the productivity statistics are misleadingly low. Unfortunately, when this is examined empirically it's difficult to find support for this hypothesis.

Another argument that current levels of productivity aren't as bad they look is that it takes time to fully incorporate digital technology into the production process; meanwhile, we have yet to fully realize the economy-lifting potential of robots, self-driving cars and other wonders that may be around the corner. This might well be true, and I am an optimist about the benefits of digital technology. But so far the gains are not showing up.

What can be done to boost productivity? Potential solutions fall into two general categories: how resources are allocated and the rate of technological innovation.

On the first problem, Jared Bernstein, former chief economist to Vice President Joe Biden and presently a senior fellow at the Center on Budget and Policy Priorities, contends that "we have been misallocating capital to non-productive finance," and that has lowered our productivity growth.

He also argues that in an economy that is operating below full employment, the theory that unproductive firms will be driven from the market by more productive competitors does not hold because "in slack labor and credit markets, inefficient firms can handily maintain profit margins by squeezing workers and rolling over cheap loans. At full employment, workers have more bargaining clout, labor costs go up, and inefficiencies become more costly."

Bernstein's solution to both problems is for the government to push hard to reach full employment through a large program of infrastructure investment paid for by a financial transactions tax. Spending on things like roads, bridges, rail lines and airports will push the economy to full employment, while the financial transactions tax would "raise the cost of non-productive, 'noise' trading."

I see two additional ways the U.S. can use its resources more productively. First, there has been a steady increase in monopoly power in recent decades. When industries are more concentrated, it leads to an inefficient use of resources. More importantly for productivity growth, firms with monopoly power have less need to maintain their market positions by developing new and innovative products and services, and they can block the entry of firms with better ideas and better products. More aggressive antitrust enforcement by the government, something the Obama administration has recently committed to, would help.

Second, how much productive talent is wasted simply because of lack of opportunity? How many women and minorities, for example, could be contributing greatly to our economy but never got the chance? Increasing opportunity so that talented individuals have the chance to reach their full potential would give the economy a needed efficiency boost. Education is one component of this, but we also need to be sure that the barriers that keep people from realizing their potential are removed.

However, while improving the allocation of our resources would help boost productivity, the major source of productivity growth is technological innovation. Historically, one source of innovation has been offshoots from government investment in basic research. Presently, as a percent of GDP, government support for basic research is at a 50 year low. Government support in this area, as well as providing incentives for similar research in the private sector, could help foster productivity-enhancing innovation.

In addition, as documented by research from Ryan Decker, John Haltiwanger, Ron Jarmin, and Javier Miranda, there has been a decline in the startup of transformational entrepreneurial firms -- the type of firms that "introduce major innovations and make substantial contributions to growth."

Unfortunately, we don't fully understand the reasons for this, and figuring out why this is happening and how to reverse it ought to be a priority for researchers in this area. In the meantime, providing whatever incentives we can through tax changes or other means could be helpful.

Productivity growth is the main driver of economic growth and a rising standard of living. By itself, an increase in productivity won't necessarily translate into rising living standards for everyone -- that depends on how the increase in output is divided among various groups in the economy. If all of the increase in output due to rising productivity goes to those at the top of the income distribution, as it has in recent decades, it won't do much for most people.

But it will be far easier to solve the problem of rising inequality if productivity is growing faster than it has in recent years, and finding ways to boost productivity and share the benefits widely ought to be at the forefront of our national policy agenda.

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