The COVID-induced government shutdown during 2020 triggered a series of government policies that affected U.S. living standards. The disruption and job losses from the shutdown produced an odd, one-time surge in productivity and living standards. This has been followed by a flat, then down, movement in living standards over the past three years. To understand the reasons for this rise and fall, it’s important to understand how productivity affects living standards.
Productivity measures the economy’s efficiency. Specifically, it measures real output in the private nonfarm sector per hour worked. Productivity is the driving force for increases in U.S. incomes and living standards. Without an increase in productivity, there can be no increase in living standards.
The chart below shows that U.S. productivity has increased at an average yearly rate of 2 percent since the mid-1950s. This seemingly modest rate has produced the extraordinary gains in living standards for the past 68 years. It’s the reason U.S. living standards are currently the highest of any major country in the world.
Historically, government policies have often been a major factor contributing to faster and slower increases in productivity. This is also the case in movements since 2019. The most stunning of these moves is the surge in productivity in the spring of 2020, when the government shut down about a third of the economy.
The following charts show that shutting down the economy in the spring of 2020 led to a one-time 4 percent boost in productivity in the second quarter of 2020. This surge in productivity was matched by a surge in living standards. In the two months from March to May 2020, annualized real earnings rose by 5.5 percent. The increase occurred for all workers as well as for production and nonsupervisory workers.
The one-time surge in productivity and earnings was a statistical anomaly. The shutdown in the economy removed many small businesses and lower-paid, nonessential workers from the workforce. The workers who kept two-thirds of the economy functioning were highly paid, essential workers. These were accountants, lawyers, and others. The jump in productivity and earnings reflected a new mix of higher earners and producers along combined with a sharp decline in low-income workers.
By the end of 2020, as workers returned, the economy snapped back. Real growth increased by 10 percent from the second quarter to the fourth quarter while productivity and living standards remained at their new, higher levels.
There are several reasons the economy maintained the increase in productivity and living standards. First, businesses undertook major technological investments to improve and refine remote communications. These changes enabled businesses to maintain, and even prosper, with far less travel and physical office space than they had previously considered necessary. Also, workers who persevered through the COVID-19 period were often paid a premium for their service because of the shortage of workers.
Unfortunately, the gains in productivity and living standards haven’t continued. Productivity and living standards leveled off in 2021, and there was a 5.8 percent surge in hours worked, which produced only a 5.2 percent surge in real growth. Productivity declined in 2022 when a 2.5 percent increase in hours worked produced a gain of only 0.7 percent gain in real growth.
In the first half of 2023, real growth was up at an annualized rate of 2 percent rate because of an estimated increase in productivity at a 1 percent rate while hours worked increased at a 0.6 percent rate. Many expect productivity to increase further when third-quarter numbers are released later this month. However, third-quarter real earnings are already available. They show a decline from the fourth quarter of 2022. If productivity has increased, it isn’t apparent from the decline in living standards.
Productivity gains are driven solely by the private sector. Government statisticians assumed there are no gains in efficiency from government. Hence, as politicians increase the government’s share of spending and regulations, it naturally crowds out the efficiencies created in the private sector. This crowding out places downward pressure on living standards.
The solution to restoring the type of productivity growth and living standards the United States has experienced throughout much of our history is clear. It’s essential to place serious limits on federal spending and regulations and return to the free-market, classical principles that once made U.S. workers more prosperous than those of any major economy in the world.
