Knowledge and Productivity

I recently wrote a couple of posts (here and here) about knowledge and its importance in economic growth and wealth creation.

I believe the basic feedback loop is:

Knowledge ==> Productivity ==> Economic Growth ==> Knowledge ...

Interestingly, productivity has been making huge gains lately. Brad DeLong, a professor of economics at UC Berkeley (and ally of Paul Krugman), writes:

On the structural side, the American economy has been growing fast over the past four years. The productive potential of the American economy has grown at an extremely rapid pace. But the rapid growth has not been the result of high investment (more capital). In fact, the rate of investment has been markedly slower than in the late 1990s. It has also not been the result of any action taken by the Bush Administration. Instead, the rapid growth is the result of:

(a) learning to efficiently use the information-technology capital put in place in the late 1990s
(b) becoming smarter about organizing production processes, and
(c) speeding up the pace of work.

This story of positive structural changes in the American economy - the very rapid growth of potential output - is the big story about the economy during the past four years. It's important both at the macro level - why is output-per-man-hour 20 percent higher than it was five years ago? - and at the micro level - how are people today doing their jobs and being 30 percent more productive than their predecessors of a decade ago? The news media aren't covering this well. Yet it's the really big story about the economy in the Twenty-First century.

Note the use phrases "learning" and "becoming smarter" which support the idea that knowledge drives the whole cycle.

Arnold Kling, an economist with a Ph.D. in economics from the Massachusetts Institute of Technology, elaborates:

Productivity is probably the single most important economic statistic. Productivity is what determines our standard of living. In the long run, productivity is what determines how much workers are paid.

(In the short run, wage growth sometimes diverges from productivity growth. If there is a sudden surge in productivity, it usually takes a couple of years for this increase to work its way into wages. Conversely, if there is a productivity growth slowdown, as in the 1970's, it takes a while for wage growth to slow down to match.)

Sustained high productivity growth would cancel out any possible economic worry. Global competition from low-wage workers? High productivity would protect our standard of living. Rising costs from Medicare? As I pointed out in The Great Race, high productivity would make the welfare state affordable (although not optimal). Environmental quality? High productivity would give us the resources to devote to addressing any challenge. On the other hand, low productivity growth would mean that our incomes will be low, our tax burden to pay for entitlements will be high, and environmental issues will be much harder to address.

The excellent productivity news is very important. It may give us a way out of our Medicare and Social Security trap and lift millions out of poverty - and more effectively and painlessly than any set of imposed government policies.