An analysis of US potential economic growth – Part IV: Total factor productivity

Summary

Growth in labor productivity is determined by growth in the capital stock, changes in labor “composition” (i.e., labor quality) and changes in total factor productivity (TFP, i.e., changes in technology and other processes). We focused on growth in the capital stock in the previous installment of this series, and we now turn to changes in TFP in this report.

TFP, also known as multifactor productivity, measures the portion of output growth not attributable to capital and labor inputs, such as efficiency and process improvements. New technologies associated with the internet and the networking of computers led to robust TFP growth in the late 1990s and the early years of the 21st century. But TFP growth slumped in the immediate aftermath of the global financial crisis and has remained weak in recent years, helping to explain sluggish growth in overall labor productivity.

There likely are a number of reasons why TFP growth has slowed, including a slower pace of technological diffusion after initial efficiency gains were realized. Yet TFP growth may be on the cusp of recovery amid a more widespread adoption of remote work and the budding AI-transition.

For remote work to have a positive effect on productivity growth, it has to allow workers to produce more output per hour worked, not simply free up more working hours through decreased commuting time. Recent studies suggest employees who worked from home performed better and produced more per hour due to an improved ability to focus. With a larger share of Americans working more from home today than pre-pandemic, remote work could be supportive of TFP growth going forward.

Early evidence also shows that AI can lead to efficiencies that increase the speed of task completion and the quality of output. AI tools generally may be better suited to complement some industries more than others, but if widely adopted, these tools can lift TFP growth.

While these advancements appear supportive of firmer TFP growth, there historically tend to be a long lag between technological advancement and efficiency gains. It's uncertain how and when increased remote work and AI will lead to efficiency improvements that manifest in TFP gains, but we expect these innovations to have similar effects as the tech build-out of a few decades ago.

In accounting for these lags, we suspect TFP growth will not reach its high watermark from the last productivity acceleration (1.9%) until the mid-2030s. A gradual ramp up to that point, however, implies that TFP growth could approach its long-run average (~1.2% per annum) by the end of this decade. Faster TFP growth in conjunction with the stronger rate of capital accumulation that we discussed in Part III positions labor productivity for faster growth in the coming decade.

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