The Sources of Labor Productivity Growth in the Frbsf Economic Letter

U.S. economy have been the subject of much study. Understanding these sources is important because labor productivity growth is the key to increasing our economic standard of living. For example, the difference between a productivity growth rate of 3% a year and one of 1.5% a year means the difference between doubling our standard of living in 23 years instead of 46 years! Theory suggests four possible sources of faster productivity growth: better trained or better educated workers, a better way to organize production, more investment in capital (equipment, buildings, and so forth), and finally, improved quality of capital, that is, equipment that works faster or better in some way. The last source—quality of capital—also is called " embodied technological change, " or ETC, to capture the idea that advances in technology are embodied in capital goods.Though many observers have attributed much of the recent productivity surge to ETC, its importance is controversial, in large part because of differences in approaches to measuring it. This Economic Letter explains what ETC is and discusses its contribution to labor productivity growth, focusing on the challenges in measuring technological change in capital goods and assessing its importance to the growth in U.S. labor productivity. Technological change and productivity Technological change—or quality change—in the context of capital refers to the productivity gains resulting from the use of new capital above and beyond the gains obtainable from a comparable amount of pre-existing capital.Take, for example, the computer at your desk. Suppose that in 2000 you spent $1,500 on a PC with a Pentium III processor and wrote 20 reports, 100 memos, and 4,000 e-mails (we'll assume for your benefit that all the e-mails were work-related!). In 2001, you replaced that PC, buying a new one at the same price with exactly the same RAM, hard disk space, and so forth, but with a Pentium IV processor. Thanks to the improved performance of your PC, in 2001 you were able to generate 21 reports, 105 memos, and 4,200 e-mails in the same amount of time—an increase in your labor productivity of 5%. Finally, suppose that the annualized cost of your computer is a constant 10% of the total annual cost of doing your job (that is, capital costs plus your compensation). Since this technological change in a component that is only 10% of the costs of your job yielded a benefit of 5% higher productivity, we …