Productivity—Not Stock Market—Shows the New Economy Lives

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The Dow Jones industrials may already be back in record territory, but the S&P 500 has yet to return to its March 2000 high of 1527, though it's moved near the 1500 level. And the Nasdaq, of course, is still off some 50 percent from its 2000 high.

Now as spectacular as those old stock market records are, don't confuse Wall Street's amazing performance in the late 1990s with the so-called New Economy. That nowhackneyed phrase referred to technology-driven change and improvement in business productivity, while the stock market's record-shattering run was merely a speculative bet on the equity performance of key tech companies. They are sometimes used interchangeably. Some of us were betting on record profits while others were merely betting that rising stocks would keep their upward momentum.

And even though the market bubble imploded—particularly Internet stocks—productivity never missed a beat, rising 2.8 percent in 1998, 2.9 percent in 1999, 2.8 percent in 2000, 2.5 percent in 2001, 4.1 percent in 2002, 3.7 percent in 2003, 2.9 percent in 2004, and 2.1 percent in 2005. Those numbers came after a quarter century of sub-2 percent growth—good news, since faster productivity means our standard of living improves more quickly.

So many economists were concerned when productivity came in at just 1.6 percent last year. Was America returning to its old low-productivity ways? If so, that was a much bigger problem than the housing slowdown. But it looks like the housing slowdown itself has been making strong productivity look bad. Here is what the econ team at Goldman Sachs recently said on the topic:

"We believe there is a straightforward explanation for slower productivity growth—the housing downturn. The sharp drop in homebuilding activity has not yet led to a significant decline in employment, so productivity in this sector is falling rapidly. Productivity growth in the rest of the nonfarm sector remains at a healthy 2.5 percent pace. Housing productivity should begin to improve within the year. Two factors—seasonal hiring patterns and the lag between the slowdown in home sales and the slowdown in home construction—have delayed the employment adjustment, but we expect declining residential housing employment to pull nonfarm payroll growth below 100,000 jobs per month in the spring and early summer."

Dale Jorgensen, productivity guru and Harvard economics professor, told me a similar story in a chat today. (I will be posting our fascinating chat at length in the near future.)

There is a huge cyclical element in the slowdown associated with the crash in residential building, and the figures ... suggest that productivity [in that sector] is going down at something like 13 percent a year. This is not a huge sector of the economy but it is large enough so that it really accounts for the slowdown in productivity relative to the trend that had been established.

And that trend, he says, is productivity growth of around 2.3 or 2.4 percent. And there is a big difference between, say, 2.5 percent long-term productivity growth and 1.5 percent. GDP itself is really nothing more than productivity growth (output per hour worked) multiplied by the number of U.S. workers. If the overall economy grew at 3 percent for the next 10 years, it would grow to $15.521 trillion. But if it grew at just a 2.0 percent rate—the difference being 1 percentage point less in productivity—the economy would grow to only $14.078 trillion, a difference of roughly $1.5 trillion. A trillion here, a trillion there, and pretty soon you're talking real money.