January 27, 2017
Like anyone in the packaging business, independent converters depend on economic growth to spur growth in demand for packaging. Ever since the last recession, optimistic economic forecasters have been predicting that annual economic growth would return to the 3 percent levels that characterized the best years before the downturn. The reality has been quite different, however. Since 2012, the fastest annual rate of gross domestic product (GDP) growth has been the 2.6 percent advance recorded last year. And at the time of this writing, it is likely that GDP growth will not top 1.5 percent, its slowest advance since the last recession. Despite rosy expectations, slow economic growth seems to be the new normal. Why is that?
Fundamentally, that slower pace of growth arises for two reasons. First, the U.S. population has been growing slowly—less than 1 percent per year—and, consequently, the entry of new workers into the labor force has been slow. And aside from adding more workers to the labor pool, output can grow only if those workers become more efficient. Yet, productivity growth has been lagging, despite the promise that advanced technology would spur new gains. The most recent data from the U.S. government shows that from the third quarter of 2015 to the third quarter of 2016, productivity in the nonfarm business sector was unchanged.
In large measure, productivity gains depend upon business investments that increase output per hour, or in infrastructure improvements such as better highways that can reduce the transit time for goods or services. Business investment has made no contribution to economic growth during the past four quarters. In the chart below, the major contributors to GDP growth are shown. The blue columns show that the contribution of business investment to economic growth has been nil since the last quarter of 2015. Even more depressive to economic growth has been the impact of inventory reductions since October 2015, shown in the yellow bars as subtractions from economic growth. According to Moody Analytics, a macroeconomic forecaster, about half of the difference between earliest estimates of 2.9 percent growth this year and the 1.5 percent likely to be achieved has been caused by depletion of excess inventories. During this year’s third quarter, the buildup in inventories added 0.6 percent to overall growth. In other words, absent that inventory growth, growth would have been only 2.3 percent, not the 2.9 percent currently estimated.
Productivity gains have been easier to achieve in the manufacturing sector than in the service sector. Indeed, when it comes to service, taking one’s time may be the ultimate definition of good service. Who wants a faster haircut? American households spent more than twice as much on services as they did for goods last year. Since 2000, the share of Americans working in manufacturing has decreased from 13 percent to 8 percent. Over the same period, the share working in health, education, and restaurant services has advanced from 17 percent to 23 percent. Over the 10 years ending in 2014, the productivity growth in these service sectors has ranged from 0 percent to –0.6 percent per year. Between 1987 and 2014, overall service sector productivity gains have averaged –0.2 percent per year, according to the Brookings Institution.
Further hampering the difficulty of achieving service sector productivity gains is the negative impact of absorbing workers whose underlying skills may not be well-suited to their new jobs. If manufacturers shed their least productive workers first, manufacturing sector productivity will improve as a result of the downsizing, but the service sector will absorb workers who may be ill-suited for their new jobs, further depressing service sector productivity.
That shift almost entirely explains the difference between the measured annual productivity growth of 1.6 percent in manufacturing and 0.2 percent in services in 18 OECD countries between 1970 and 2005, according to Alwyn Young, an economist at the London School of Economics and Political Science.
Research suggests that there is room for improvement in service sector productivity. OECD research suggests that the most productive service firms were three to four times more productive than laggards in 2013. The top 5 percent of firms studied showed labor productivity growth of 3.6 percent per year, on average, almost 10 times as fast as the bottom 95 percent. This research suggests that reforms to remove barriers to entry and to promote competition in services, especially in health and education, could have a powerful impact on productivity growth.
But, until those gains are realized, economic growth in developed economies around the globe is likely to continue advancing at rates of less than 3 percent per year, limiting the prospects for rapid gains in packaging demand.
Dick Storat is president of Richard Storat & Associates. He can be reached at 610-282-6033 or storatre@aol.com.
