In recent years, official estimates of labor productivity growth have shown a significant slowdown. But many argue that the government has failed to correctly estimate productivity. This argument was made recently in a Wall Street Journal article featuring Hal Varian, Chief Economist of Google. The piece prompted an elaborate discussion in the blogosphere.
Mismeasurement of productivity likely results from mismeasurement in any of the three components used to construct productivity measures:
- The number of actual dollars being exchanged for production
- The real value of production, which adjusts the dollars paid for production for price changes and quality improvements
- Labor input or number of hours worked, which is used to calculate real value of production per worker or hours of work
Most of the mismeasurement discussion has to do with the second point, the real value of production, and rightly so. Measurement issues with the actual number of dollars being exchanged for production or with labor input do not explain the productivity slowdown.
So how is the real value of production being mismeasured? Official statistics cannot fully account for all of the cheap or free benefits that consumers get from new technologies. In other words, the true value of production is higher than the official estimate, because official statistics have failed at the Herculean and possibly unnecessary task of capturing total consumer benefit.
So it seems that productivity is actually growing faster than official estimates indicate. What are the implications of this mismeasurement?
Faster productivity growth typically leads to:
- faster growth in living standards;
- better fiscal health, reflected in a lower debt-to-GDP ratio; and
- faster growth in corporate profits as a result of faster growth in revenues relative to expenses.
In some of those cases, mismeasurement has large implications. In other cases, it has no implications at all.
Areas in which mismeasurement makes a difference:
- Living standards: The true standard of living of the population is underestimated due to mismeasurement of the benefits to consumers of new technologies.
- Real wages: There is a common belief that the real wages of much of the US population have stagnated or declined in recent decades. If true inflation (adjusted for quality improvements and new products) is indeed significantly lower than official inflation, then this wage stagnation argument is exaggerated, and consumer purchasing power is higher than commonly believed.
- Various payments in the economy are directly or indirectly adjusted according to the official inflation measure. If official inflation is overestimated, using this measure masks true increases in the cost of living.
Areas in which mismeasurement makes no difference:
- Corporate profits: Mismeasurement does not impact corporate profits because it does not impact the dollar amount of revenues or expenses.
- Future Debt burden: Mismeasurement does not impact future debt because it does not has no impact the dollar value of GDP, debt, tax revenues, or government expenditures.
In sum, it seems that official statistics are now and will continue to underestimate productivity growth. How should we feel about this?
First, improvement in the average American’s standard of living is better than we thought. Second, and this should be the main takeaway from this blog, we should not feel any differently about the financial health of businesses and about national, state, and local governments. The mismeasurement is not about actual dollars. Therefore, correcting the mismeasurement does not impact measures of dollars being exchanged.
 See, for example, TCB Chief Economist Bart van Ark’s response, Blaming the productivity slowdown on measurement issues takes our eyes off the ball.