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2003 Annual Report—Federal Reserve Bank of Dallas

A Better Way
Productivity and Reorganization in the American Economy

Compare America today with earlier times or other nations, and one fact stands out: We live better.

Give most of the credit to productivity. Through it, we get more goods and services from each bit of work effort. Through it, we secure economic progress and earn bigger paychecks. The power of productivity has made the United States the world's richest nation.

America has prospered by doing things a better way.

We've become more productive by building our capital stock—adding more machinery, factories, offices and research facilities.

We've become more productive by upgrading workers' skills, whether through formal schooling, on-the-job experience or retraining.
We've become more productive by introducing new technologies that increase output, improve efficiency and lower costs.

We've become more productive through trade, too. Open markets force companies to strive harder to compete. Through trade, companies gain access to cheaper inputs, a deeper pool of investment funds and technology from around the world. Trade enlarges markets so companies can exploit economies of scale.

Most Americans readily recognize—and celebrate—the forces that raise productivity in the workplace, but there's more to this engine of economic progress. As companies and workers achieve greater efficiency at the microeconomic level, they unleash a power that reorganizes the whole economy, spurring further productivity gains at the macroeconomic level. (See Exhibit 1.)

Exhibit 1

The Path to Progress

Economies boost their productivity in two ways-micro and macro. Microeconomic gains take place within an enterprise as it invests, trains workers, innovates and competes. Macroeconomic gains occur when the overall economy reorganizes, shifting resources so they produce more than before. Both types of productivity make us better off. Statistics capture productivity's capacity to increase consumption and leisure, but they ignore other gains, such as better working conditions, new and better products, and greater variety.

Microeconomic Sources of Productivity Growth

Investment
Increasing the capital goods with which labor works raises output. In recent years, America has been putting more than 10 percent of its GDP into adding to its stock of machinery, factories, offices and research facilities.
Innovation
New technology has always played a leading role in raising productivity, by boosting output, improving quality, and saving time and other resources.
Education and Training
Workers become more productive when they upgrade their skills and talents. Building human capital starts in the classroom, but modern economies reward workers for a wide range of abilities.
Trade
Open markets intensify competition, giving companies greater incentive to lower costs and improve quality. Trade also provides access to technology, inputs and capital that might not be readily available at home.

Trade
Macroeconomic Sources of Productivity Growth
A powerful force for reorganization, trade makes economies more productive, even if enterprises don't become more efficient.

Reorganization
Macroeconomic Sources of Productivity Growth
As companies and workers become more efficient, the economy reallocates resources to more productive uses, either in existing companies or new ones. As the market recycles workers and other resources, the economy grows.

Measured
The Payoff from Productivity Growth
Higher GDP More leisure time
Unmeasured
Better working conditions New and improved products More variety Greater safety and security Cleaner environment

Resources from streamlined operations aren't just cast out into idleness. With less labor needed to produce the existing output level, workers' talents and energy become available for other tasks, either at companies already in business or at new enterprises. Reorganization expands production throughout the economy, fulfilling wants that had been unmet or maybe even unknown.

Reorganization from trade provides another source of macroeconomic productivity. As competition forces producers to seek comparative advantage in the marketplace, resources shift to their best uses, creating a more efficient economywide deployment of labor.

America's history has been one continual upheaval in jobs—first off the farms and into factories, then on to services. The economy's relentless reorganization raises productivity.

History shows us the power of macroeconomic productivity in action. At its founding America was primarily agrarian, with more than 90 percent of the population toiling on farms. As tractors, threshers, irrigation and high-yield seeds made individual farmers more productive over the past century or so, the United States could feed itself—and expand its export markets—with far fewer agricultural workers.

Displaced farmhands flocked to cities, where they found work assembling cars, building houses, generating electricity and making an abundance of consumer goods. Over time, factories grew more automated and saw great leaps of productivity. Workers moved from assembly lines to jobs in retailing, medical care, finance, management and services.

Over the grand sweep of history, the cumulative effects of productivity on living standards have been astounding. Per capita output has grown 25-fold since 1776. In just the past two generations, average real income in the United States has more than doubled, thanks largely to increased output per hour.

Productivity has also allowed Americans to reduce the average workweek from 76 hours in 1830 to 60 in 1890, 39 in 1950 and just 34 today. All told, productivity provides something close to economic alchemy: more for less. We get more of the goods and services we want for less time at work.

Human beings possess some innate instinct to innovate and improve, but productivity advanced at a snail's pace for much of history. American farmers in the early 1800s worked the soil the same way their European forebears had for centuries. Not surprisingly, their living standards were about the same, too.

The advent of industrial capitalism in the 19th century quickened the pace of progress by providing a powerful, even ruthless impetus for productivity. The competitive hothouse of capitalism pits producers against one another in a contest for resources and customers. Market discipline rewards those who produce and punishes those who plunder. Winners in the productivity race reap increased profits and gain market share, while losers see their capacity to compete shrink until they eventually go out of business.

The efficiency gains that make firms leaner and the economywide reshuffling of jobs require painful adjustments. Some see only the hardships. Fearful of job loss and upheaval in their lives, such people have a single message: Preserve the status quo. What they fail to see is that society must endure the turmoil to get the payoff from productivity.

Taken together, micro- and macroproductivity are a potent brew for economic progress. Through a succession of technology revolutions and industrial reorganizations, the nation advanced from the horse-and-buggy age to one of jet travel, satellite communications, robotics, genetic engineering and the Internet—all generated by waves of productivity.

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