The US economy has raised its game - can we follow suit?

The flood of money into technology in the States has been extraordinary. Now, it seems, it's pay-off time
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The Independent Online

The most stunning economic news of this week has been the surge in US productivity. Not only are American workers the most productive in the world, they are increasing that productivity at an amazing rate.

The most stunning economic news of this week has been the surge in US productivity. Not only are American workers the most productive in the world, they are increasing that productivity at an amazing rate.

The figures show that in the year to end-June the productivity of American workers grew at the fastest pace since 1983, an annual rate of 5.3 per cent. This tops the already remarkable rise of 5.1 per cent in the year to end-March.

The news sparked immediate speculation in the financial markets that there would not need to be another rise in US interest rates on 22 August when the Federal Reserve's Open Market Committee next meets. Why so? Well, wages in the States have been rising at 4.7 per cent a year, which taken in isolation might seem to have disturbing implications for inflation. But if productivity is rising even faster, then there need be no inflationary impact: US firms can pay their workers that sort of increase and still see a fall in their unit labour costs.

That, however, is just the short-term impact: market practitioners make money for themselves and their clients by getting these short-term movements right, so it is understandable that they should focus on this. What matters for the rest of us is whether these numbers are giving us a glimpse of a prolonged period of prosperity, initially in the US but if we get things right here, in Britain and presumably Europe too.

When you get stunning stats the first question to ask is "Are they right?" This is particularly the case with productivity in a service economy, because it is hard to measure quality of output in services. But, until about three years ago, the remarkable thing about the US economy was that it was not improving its productivity much.

There, companies were making enormous investments in IT equipment and yet they did not seem to be getting much benefit from that cash. But they kept on spending. The flood of money into technology in the second half of the 1990s was extraordinary, as you can see from the graph: increases of 20 per cent plus compound. By contrast, regular industrial investment has been rising by less than 10 per cent a year and in some periods has gone negative.

Now, it seems, it is pay-off time. Of course it is possible that the figures do exaggerate the rise in US productivity that has been taking place. It is possible too that part of this productivity gain is simply the result of running the economy at yet higher levels of output - getting it so close to full capacity that these increases cannot be sustained in the longer-term. But even if they do overstate the rise it is likely that some sort of step-change has taken place in the US. It has lifted its game.

This would figure. Whenever new technology comes along it takes a while for human ingenuity to work out ways to use it. This happened when electricity revolutionised factory design. Instead of workers having to be clustered around a central power-source, the drive belt of a steam engine, they could be put along a production line driven by electric motors spaced along it. This used human labour much more efficiently, but it took 20 years to work this out.

Now the US has had only five years to figure out how to use the internet in ways to boost productivity because commercial applications of the Net had to wait on the invention of the World Wide Web and the browser. True, IT investment had been running hot and strong before this, but the take-off in investment really has been post-Net, as the graph suggests. So it would be reasonable to expect there to be a surge in productivity now, as applications boom.

It would also be reasonable to expect this period to last at least a decade, probably two. Simply applying what we know now can be done with existing technology will enable enormous increases in productivity in areas like airline reservations, e-banking, e-procurement and so on. We have to assume the technology will continue to leap forward rapidly as high-speed access spreads and mobile telephony develops. So there are going to be lots of further increases in productivity in the pipeline. The latest estimates for the sustainable growth rate for the US economy of 3.5 to 4 per cent appear plausible. Add in a population growth factor and the US begins to look like a 4 per cent growth economy.

If that is right lots of things change, and change for the better. For example the potentially worrying arithmetic of the social security deficit becomes less worrying. Social security aside, surpluses loom forever. The game of government in the US will be deciding not whether to cut taxes but how much to cut them by. Even a short recession (and it would be silly to pretend that one will never occur) would merely delay the progress to these sunlit uplands.

And Europe? Well, we do not yet have much evidence of sustained productivity increases, certainly not on the US scale. If the same sort of explosion of productivity is to occur, the UK is as good a place to look as any. UK investment in information and communications technology is running even higher than in the US and Net penetration is running only about a year behind. But so far nothing much seems to be happening. Sure, growth is good by continental European standards, but that is not a great standard. The message must be to watch the figures for an early sign that in this area, as in so many others, we will follow the States.

Elsewhere? Scandinavia and the Netherlands are the other main candidates where a surge in productivity ought to be occurring. If that does happen (and again there is not much evidence yet) then eventually the message will spread southwards. But it will take time. That question that so disturbed the EU heads of government at the Lisbon summit last spring still should haunt us: "Can Europe catch up?"