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Macro Outlook

Declining Potential

By Elliott H. Gue, on Oct. 10, 2016

Productivity growth is an important factor in how well an economy performs, particularly over the long term. A perfect example of this is the high-growth period of the 1990s and early 2000s, which, believe it or not, has important implications in the current environment.

Between 1990 and the end of 2006, total hours worked by US workers in private industries grew 27 percent. This time span also saw the US population grow by 54 million (22 percent), tens of thousands of new businesses created and the labor force jump by 28 million (24 percent).

As measured by the total output of goods and services, the US economy grew by more than 66 percent, even when adjusting for inflation.

Despite the economy’s strength, there was almost no growth in hours worked on a per capita basis. Instead, the increase in the total hours worked was a result of the swelling US labor force.

Since the economy grew at more than twice the pace of total labor hours, US workers must have produced more goods and services per hour worked than before.

Economists call this measure of economic output per hour worked labor productivity. It’s considered one of the most important long-term indicators of an economy’s performance.

Another way to think of labor productivity is the relationship between economic growth and unemployment, the latter being a proxy for total hours worked.

Understanding this relationship helps explain a basic paradox in the US during the last few years: weak economic growth, coupled with a rapid drop in the unemployment rate.

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