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Time to Invest in Future Competitiveness

Quarterly U.S. Productivity and Competitiveness Snapshot

SOURCE: AP/ John Gress

While productivity has been increasing, public investments in education, science, and research and development are need to drive private-sector innovation and productivity to the frontier of possibility and beyond.

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Productivity growth—the rate at which we increase production with a given amount of work and resources—is at the heart of economic growth. Simply put, productivity growth means we can have more goods and services available for a given amount of resources used—hours at work, in particular. It will be easier to address the myriad challenges facing the U.S. economy—increasingly fragile middle-class living standards, the economic needs of an aging population, the long-term federal budget deficits, the environmental consequences of economic activity, and increasing competition from rapidly developing countries—if productivity grows faster and economic growth accelerates along with it.

Productivity growth boosts our future living standards because productivity growth makes any given amount of time at work go further. We still need to address how the gains from productivity growth are distributed between wages and profits to ensure broadly shared prosperity, but without productivity gains there wouldn’t be anything to distribute. Productivity growth essentially grows the economic pie, while policy choices decide the size of each slice of pie going to America’s middle class and the wealthy.

Productivity growth is also critical to our national economic competitiveness. U.S. products and services are more competitive in the global marketplace when U.S. firms manage to produce more and better things with the same amount of inputs.

A number of key factors come into play in determining faster productivity growth in the future. These include the level of business investment, the availability of skilled workers, spending on research and development, and adequate financing for bringing new and innovative products to market. The indicators of U.S. productivity and innovation surveyed here raise a number of points of concern about the future of U.S. economic competitiveness and living standards:

  • Though accelerating, productivity has increased at a modest pace since the start of the current business cycle in December 2007. Erosion in the U.S. high-tech trade deficit and declining domestic patent grants suggest the U.S. economy’s competitive edge may be dulling.
  • Business investment, while recovering, remains historically low. Corporations are not directing their rebounding profits to productivity-enhancing activities, instead holding cash or spending the money to buy back their own shares and pay out dividends to shareholders.
  • Private venture-capital investors are reluctant to fund early-stage innovative business ideas.

Productivity growth doesn’t just fall from the sky; it requires sustained policy attention to create private incentives and to supply complementary public investments. Currently, many critical public investments in education, scientific research and technological development, and commercialization are facing the risk of steep “sequestered” cuts agreed to in a deal to raise the debt ceiling this past summer. As Congress returns for the 2012 session, it is imperative for leaders to revisit this decision and refocus the public debate on ways to responsibly address long-term fiscal challenges with the real national economic priority of securing American productivity and competitiveness. Here’s why.

Productivity growth picks up with an accelerating economy

Worker productivity, the amount of goods or services produced in an hour of work, accelerated by 2.3 percent in the third quarter of 2011 as the overall economy recovered from the shock of last summer’s debt limit uncertainty. Though productivity in the U.S. economy is 7.4 percent larger than at the start of the Great Recession—and the current business cycle—in December 2007, the growth in productivity is lagging the pace of previous business cycles. There have only been two business cycles since the Great Depression that lasted at least as long as the current one and that had lower productivity growth during this period. All six other such business cycles yielded faster productivity growth.

Productivity growth tends to follow business investment with a long-time lag—investments today lead to productivity growth one or two decades down the road. Business investment in equipment, software, and factories, as we discuss next, has been at or near historic lows for a decade now and in part explain why productivity growth remains relatively slow in the business-cycle recovery. And low investment today may likely constrain productivity increases in the future.

Some business investment recovering

Since March 2010 business investment grew faster than gross domestic product or GDP—the sum total of all goods and services produced by workers and equipment in the United States—although it grew from very low levels. Business investment stood at a little over 10 percent of GDP in the third quarter of 2011, and has averaged just 10.3 percent of GDP for the current business cycle—the lowest average of any business cycle since the late 1960s.

Business-equipment investment expanded strongly in the third quarter of 2011, growing by 15.7 percent. Some of this growth reflects investments delayed by business owners due to uncertainty over the debt ceiling deal. But some also reflects an economy recovering from shocks earlier in the year and building on the business spending spurred by the American Recovery and Reinvestment Act of 2009. Such business investment fell to a low of 6.4 percent of GDP in the second quarter of 2009. As the Recovery Act stimulus began kicking in, the demand it propelled from private businesses for investment goods helped boost equipment spending to now more than 7.5 percent of GDP.

Business investment, though on the upswing, will only gain momentum if businesses expect more sales in the future. Additional sales can come from stronger consumption at home and from more exports. Rebounding profits fuel cash holdings, share repurchases—not productive activity

The slow recovery of business investment has little to do with business profitability. The corporate profit rate in nonfinancial businesses, which fell to 1.5 percent of total assets in December 2008, has recovered and has been consistently at or above 2.6 percent in 2011. But with these profits, corporations are prioritizing activities other than hiring and productivity-enhancing investments. First, corporations are stockpiling cash holdings, which stood at 7.2 percent of total assets in September 2011, down 0.1 percentage points from June 2011, which was the highest level since December 1959.

Second, corporations are using rebounding profits to prop up their stock prices—a key factor in executive compensation—by repurchasing shares and paying out dividends. The total corporate resources devoted to propping up share prices amounted to 108 percent of after-tax profits on average between December 2007 and September 2011. This means corporations are actually borrowing money to buy back their own shares and pay dividends, rather than putting that money into productivity-enhancing investments or hiring workers.

Venture-capital investment neglecting early innovation

Investments by venture-capital investors are also recovering slowly. In the four quarters through September 2011 venture-capital investments amounted to more than $27.1 billion, up 13.5 percent over one year prior, but still 15 percent lower than before the financial turmoil in the second half of 2008—and less than one-fourth of the level at the end of the 1990s dot-com era, after adjusting for inflation.

The slow recovery of VC funding reflects less a lack of opportunities or resources and more a lack of risk appetite from VC investors. Financing for expansion and late-stage VC investments is up more than 22 percent since the start of the current business cycle. Over the same time, however, VC investments in seed-stage companies have fallen by 41 percent after adjusting for inflation.

With low overall investment and employment creating uncertainty for economic growth, venture capitalists are seeking more proven investments over riskier startup businesses and innovations. Many viable and transformational innovations are potentially not being brought to market because of the private sector’s unwillingness to finance such investments.

Advanced technology trade balance deteriorates sharply

The U.S. trade deficit in high-tech goods, such as aircraft, optical equipment, and medical devices, worsened 50 percent to more than $97 billion in the 12 months through October 2011, the last month for which we have data. For the past two years, U.S. exports of advanced technology goods have grown at 3.1 percent annually. At the same time, U.S. high-tech imports—already larger than exports to begin with—grew 8.3 percent annually to $385 billion. On an annualized basis October 2011 marked the third largest high-tech trade deficit on record.

The trend in the high-tech trade deficit is not a result of the overall direction of other U.S. trade. Compared to other U.S. exports, high-tech exports are growing slowly. In contrast to high-tech exports, other U.S. exports grew 20.4 percent annually for the past two years. While U.S. exports are becoming more competitive overall, the U.S. high-tech sector is not keeping pace. Lagging performance of advanced technology trade also weighs on the overall U.S. trade deficit. The share of the high-tech trade deficit in the total U.S. trade deficit increased from 12.5 percent one year ago to 13.6 percent in October.

Domestic innovators still losing ground to international competition

Grants for utility patents from the U.S. Patent and Trademark Office grew markedly in 2010, up 31 percent over 2009 to nearly 220,000 grants. Utility patents are special property rights awarded to individuals or organizations for the invention of “new and useful” or material improvements of processes, machines, or materials—namely, innovations. Not all patents represent productivity-enhancing innovation, and the timing of patent grants may not coincide with the timing of invention. Nonetheless, the pace of patent awards provides a metric of the pace of innovation in the U.S. economy.

Even though patents overall were up in 2010, the share of patents awarded to domestic U.S. entities continued to decline. Under U.S. law, both Americans and foreigners can apply for patent rights. Of new patent awards in 2010, 51 percent were granted to foreign entities; in 2000 foreign entities earned only 46 percent of all patent awards.

Innovations from abroad can still confer substantial benefits on the U.S. economy. By making new technologies or practices available to domestic businesses and consumers, foreign innovations can enhance business productivity and boost living standards for U.S. households. But homegrown innovation remains critical to U.S. global science and technology leadership, and the rising awards of patents to foreigners signals an increasingly competitive international landscape for innovation.

Conclusion

The U.S. economy will not regain its productivity and competitive edge on its own. Public investments in education, science, and research and development play an essential role in driving private-sector innovation and productivity to the frontier of possibility and beyond. Returning to Washington in 2012, policymakers should refocus their sights on ensuring America makes the necessary investments today to secure productivity and innovation for the future competitiveness of the U.S. economy and its workers.

Adam Hersh is an Economist at the Center for American Progress. Christian E. Weller is a Senior Fellow at the Center and an associate professor of public policy at the University of Massachusetts Boston.

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