Boom Increases Productivity

There’s a noticeable surge in productivity across America, possibly due to a few factors: inflation seems to be under control, even with rising wages, and the economy is seeing significant growth.

This Thursday, the government revealed that productivity increased at an annual rate of 4.9%. This figure reflects a steady trend, similar to the 4.1% seen in the third and second quarters of the previous year. Interestingly, these recent numbers mark the best consecutive quarters since Trump was in office last.

But it’s worth noting that this figure might actually underestimate the underlying trend. During the pandemic, productivity spiked as many individuals faced layoffs. Typically, in a recession, less productive workers are let go, which can boost the output-to-hours-worked ratio that measures productivity. Now, with productivity over 4%, it’s coupled with a stable unemployment rate and increasing production.

There are emerging signs we might have entered a new phase of high productivity growth. After some surprisingly positive productivity reports in 2023, economists at the Cleveland Fed are analyzing potential shifts in productivity patterns. Their statistical model suggests a 40% chance that we could be transitioning into a high-growth period, although further evaluation is needed.

What Drives Increased Productivity?

This productivity boom has economists scratching their heads. I think many feel that it’s a bit premature to cite artificial intelligence as the main driver. The rapid rise in manufacturing productivity hints that broader innovation investments, not just AI, might be the key factor here.

So what could be fueling this trend? One likely reason is a tight labor market, combined with the waning practice of offshoring. For years, companies benefitted from easily accessible cheap labor, both domestically and internationally. However, many are starting to understand that to expand, they need to shift their focus toward domestic investments.

Even with Trump out of office, the old immigration policies from previous administrations are unlikely to return, nor can we expect a revival of globalization as we knew it.

Another element to consider is the tax incentives for capital investments introduced through recent legislation. By permanently allowing 100% expensing of capital expenditures, businesses may feel encouraged to invest more heavily and adopt models centered around capital rather than labor costs. The old tax framework provided immediate deductions for labor costs but spread out capital deductions over several years, making investment less attractive. The new rules seem to create a more balanced approach.

However, Trump’s influence on policy can’t be overlooked. The productivity increases documented in 2023 and 2024 caught Cleveland Fed economists’ attention, but they were also spurred by strong backers of Trump. In an unexpected twist, tariffs from Trump’s earlier administration remain intact, signaling to companies that they needed to adjust quickly.

The labor market during this period was notably tight, with job openings far outnumbering available workers. Trump’s immigration and tariff policies during his subsequent term continued to shape these dynamics. The slow workforce growth and rising costs associated with imports have significantly impacted the economy, resulting in a dramatic increase in the relative return on domestic productivity investments.

This situation contradicts the expectations of tariff critics, who argued that tariffs would push workers into less efficient industries, leading to lower productivity. What they missed was the extent to which international economic factors had skewed global production. The realignment toward domestic production could enhance productivity and lead businesses to embrace technologies that improve efficiency.