Declining productivity growth has been a widely discussed concern in recent years, and we’ve recently discussed it from several angles on this blog (here, here, here). But we thought it might be helpful to take a step back to better understand what productivity really is, and why it’s so important to businesses, industries, and economies.
It’s no secret that a business grows by selling more goods or providing more services. But a business cannot accomplish these without either: 1) increasing the aggregate number of hours that employees are producing (existing employees working more hours or hiring more people); or 2) by getting employees to produce more given the same number of hours, or to put it another way, increase productivity.
How does a business increase productivity? The most common way is to purchase new equipment and/or technology, known as capital investment. For a goods producer, this might mean providing employees with better tools; for example, a construction company replacing standard hammers with nail guns will almost certainly increase productivity over time. On the services side, if a bank upgrades an outdated computer system, it can increase the speed at which employees can serve customers, allowing more customers to be served by the same number of workers.
In the case of U.S. energy, a combination of both factors (better equipment and advancements in technology) have enabled the industry to dramatically increase productivity in recent years, which enabled producers to access previously inaccessible wells, as well as maximize each well’s output. This translated into a dramatic increase in production levels, as the chart below shows. As a result, the U.S. has overtaken Saudi Arabia as the world’s de facto swing producer.
Ultimately, capital investment often leads to increased productivity, which leads to business growth. And if businesses in aggregate are making smart investments in capital goods, it should help grow the economy as a whole. This is the reason that productivity growth is followed so closely by market participants, and the reason we continue to monitor capital investment as a potential leading indicator of productivity gains that may help fuel economic growth moving forward.