For release on delivery
12:35 p.m. EST
November 30, 2022
The Economic Outlook and U.S. Productivity
Remarks by
Lisa D. Cook
Member
Board of Governors of the Federal Reserve System
at the
Detroit Economic Club
Detroit, Michigan
November 30, 2022
Good morning. It is a pleasure to be back in Michigan, although I wish I had
been here to participate in the Turkey Trot last week, which is an annual tradition for my
family and me. It is especially a treat to be back in Detroit, with its rich history of music,
art, architecture, and industrial innovation-which I will address today. I am also
delighted to see some familiar faces.
Today, I would like to discuss the economic outlook and focus on one particularly
important aspect of the economy: productivity. I have spent much of my career
researching the ways in which American ingenuity and invention can be wellsprings of
economic growth. I am here, therefore, to address the impressive innovation happening
in the auto industry and what it tells us about future prospects for productivity in the U.S.
manufacturing sector and in the economy more generally. I can think of no better place
to do that than in the Motor City.
Outlook
To set the stage, I will first turn to the U.S. economy as a whole, where inflation
remains much too high. As a result, the Federal Reserve must continue to focus on
bringing inflation back down to our 2 percent target.
We have begun to see some improvement in the inflation data. The October
report on consumer prices was encouraging, particularly the slowing in core inflation-
the measure that excludes more volatile categories, such as food and energy. Producer
price inflation also moderated in October, suggesting that inflation pressures on
businesses may be easing. Nonetheless, I would be cautious about reading too much into
one month of relatively favorable data.
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Core goods inflation has finally begun to slow significantly, helped by some long-
anticipated improvement in global supply chains. Declines in wholesale prices for used
cars and in prices for key manufacturing components, like plastic resin and steel, also
suggest continued moderation in goods price inflation.
Services, however, make up about two-thirds of consumer spending, and inflation
in that sector has not yet slowed. Notably, inflation in housing costs shot up this year and
will likely contribute substantially to overall inflation for some time. Nonetheless, some
good news is emerging on this front. Rent increases on new leases have slowed in recent
months. And a substantial number of multifamily units currently under construction will
be delivered next year, helping to ease the housing shortage. Still, these positive
developments are likely to feed into measured consumer prices only gradually.
Services prices more broadly have accelerated sharply this year and may prove to
be a persistent factor keeping inflation elevated. Demand for services continues to
recover from its pandemic lows, with the release of pent-up demand for travel evident to
anyone who has spent much time in DTW and other airports recently.
Labor compensation is a key factor for non-housing services prices, and growth in
labor costs remains well above pre-pandemic rates. There has been some moderation
recently, with slowing in average hourly earnings and in the employment cost index. But
wage growth remains above what would be consistent with 2 percent inflation, given
prevailing trends in productivity growth.
Productivity
In Michigan and the other parts of the country that boast manufacturing hubs, we
all understand the importance of productivity. Productivity growth is a key factor in the
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health of the overall economy and in the daily lives of all Americans. Because
ultimately, it drives rising standards of living for all of us.
Growth in labor productivity, or output per hour worked, has been lackluster in
the U.S. economy and around the world in recent years.1 Some observers fret that we are
running out of innovative ideas to squeeze more outputs from the same inputs.2 Others
look around and see amazing technology used in cutting-edge factories, warehouses, and
stores and wonder if the innovation is happening but not spreading as fast as it once did.
Whatever the cause, in recent years output per hour has only increased at half the rate it
did as recently as the mid-2000s. This is cause for concern.
Over the first three quarters of 2022, productivity in the business sector has
recorded a disappointing decline of 33⁄4 percent at an annual rate. Payroll employment in
the private sector has continued to increase, yet gross domestic product (GDP) has done
little more than move sideways, resulting in an outright decline in labor productivity.
However, the recent decline in productivity is partly an artifact of the pandemic. In 2020
and 2021, productivity soared when firms found ways to keep producing while many
employees were away from the workplace (figure 1). Meanwhile, the economy shifted
away from services-a lower-productivity sector-and toward goods-a higher-
productivity sector-as households substituted new televisions for dining out and family
vacations. As a result, average productivity moved up. These temporary changes have
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largely reversed, leading to the recent declines in productivity, pushing it back toward its
pre-pandemic trend. The tight labor market has played a role, as well. With 1.8 job
openings for every job seeker, firms may be using the GDP slowdown as an opportunity
to let their hiring catch up to the earlier surge in labor demand. Some firms may even be
operating with a larger workforce than necessary in order to hold on to talent they may
not have retained in normal times.
In any event, we should avoid making too much of quarterly swings in choppy
data but focus instead on the trend over several years. Taking this longer view, what pace
of productivity growth should we expect going forward? This question is critical to
policymakers, as inflation is tied to productivity. When firms see rising output per hour,
they have room to keep prices low. For consumer goods, this can help lower inflation.
For material inputs, this lowers the cost of downstream production. And for equipment,
lower prices mean more capital investment, a knock-on effect that boosts productivity
further.
If there is a productivity revival, it will likely involve manufacturing, if history is
our guide. When it comes to productivity, the sector has a record of punching above its
weight. Since the mid-20th century, manufacturing productivity has risen a full
percentage point faster than productivity for the broader economy (figure 2). The sector
seems to find ways to do more with less. For example, manufacturing lost a staggering 5
million workers from 2000 to 2019, nearly 40 percent of its workforce. As seen in
Michigan, this meant difficult transitions for industrial workers and their families as the
economy shifted toward services and substituted imports for domestic production. Yet, at
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the same time, output as measured by the Federal Reserve's industrial production index
continued to climb.
Since the mid-2010s, though, this relationship has reversed, and manufacturing
productivity has been noticeably lower than that of the overall economy. What explains
the anemic growth in recent years? For one thing, IT equipment manufacturing has
moved offshore, taking the productivity gains from progressively smaller and faster
computer chips with it.3 More generally, offshore locations have focused on production
of high-volume goods. Many of the remaining U.S. plants produce more specialized
products, which tend to require more specialized labor and have lower productivity
growth.4
The motor vehicle industry has mostly defied this trend of offshoring final
production. The U.S. motor vehicle industry still produces more than 10 million vehicles
a year and employs 1 million people at assembly plants, labs, and suppliers.
Furthermore, it is an extremely innovative industry, and fierce competition forces
automakers to roll out innovations quickly. Dozens of motor vehicle research and
development labs reside in Michigan alone, churning out ideas for vehicle safety, fuel
efficiency, comfort, and style. And with each passing year, cars and trucks look more
like computers on wheels.
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Looking around Michigan today, I see all kinds of changes. Some changes are to
the production process, like the newest generation of robots. These communicate at
lightning speed, using the same high-speed "5G" technology as the latest phones; utilize
artificial intelligence to adapt to their environment; and operate safely right next to
workers on the assembly line. Some changes are to design, like collision avoidance
systems, sophisticated navigation apps, and the dozens of electric vehicles now on the
road or coming to market soon.
Some observers look at these changes with trepidation. Robot orders surged after
the onset of the pandemic and have continued apace, a partial solution to the critical
shortage of labor in manufacturing.5 What does all this mean for production line
workers? Motor vehicle manufacturers have been the most intensive users of robots for
decades. The first assembly line robot was rolled out in 1961 by General Motors in
Trenton, New Jersey. Yet, the motor vehicle industry still employs more than 1 million
workers, and its share of manufacturing employment has been going up since 2010. How
did that happen? Research has shown that workers are not just suited for a single job-
they have a bundle of broadly applicable skills. When robots take over one task, workers
are shifted to another task and, in turn, new tasks appear.6 The set of tasks to perform is
not fixed, a belief economists call the "lump of labor fallacy." Rather, we need
production workers to work with the new equipment and to focus on the problem-solving
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that robots do not do well. That means that the next generation of plant workers will use
touch screens a lot more and rivet guns a lot less.
And the systems they install as they assemble the vehicles are more laden with
electronics with each passing year. Many are anticipating the arrival of the self-driving
car, but in some respects, it is already here. Vehicles can parallel park themselves with
the touch of a button, stop you from drifting out of your lane, and follow the car ahead of
you, keeping a safe distance.
While the U.S. is not making as many semiconductor chips anymore, we are using
a lot of them. If that was not apparent already, we learned that lesson the hard way
during the pandemic. I understand that, even now, thousands of vehicles are all but built,
parked while they await missing chips. The increasing share of electronic content in
vehicles contributes to that delay, as does the shift toward electric vehicles, which may
have two or three times the chip content of an internal combustion vehicle. The shortfalls
in supply and corresponding price pressures have eased somewhat, but they have not
disappeared.
Highly innovative companies in the motor vehicle industry-as well as
pharmaceuticals, biotechnology, and, of course, information technology-stand out as
leaders in driving the quality of goods up and the cost of production down. Why isn't
that showing up in productivity? For one thing, it takes time. History has shown that
major innovations take years for their effects to be fully manifested. Firms have to
reorganize production-including changing the layout of plants, rethinking management,
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and reshuffling workers-to maximize their talents.7 Electrification of the manufacturing
sector took decades as plants were redesigned and rebuilt to exploit the flexibility of
getting away from steam power.8 Likewise, we still have not seen the last of the changes
that the IT revolution will bring.
Productivity-enhancing ideas spread more quickly in more dynamic
environments. When labor and capital move quickly toward their best uses-at the more
productive firms-overall productivity accelerates. And when firms have close
competitors on their heels, they may adopt new techniques faster.9 Entrepreneurship
plays an important role in this process. Sometimes, a new idea needs a new firm not
committed to old ways of doing business. This kind of dynamism has diminished in
recent years, though the surge in business creation in the past two years may be an
encouraging sign.10
Indeed, the U.S. manufacturing sector is healthy. The recovery from the
pandemic downturn has been remarkable, especially in comparison to the Great
Recession. The sector is currently producing at 3 percent above its pre-pandemic level.
And, importantly, October marked 18 consecutive months of increasing manufacturing
7
See Erik Brynjolfsson, Daniel Rock, and Chad Syverson (2021), "The Productivity J-Curve: How
Intangibles Complement General Purpose Technologies," American Economic Journal: Macroeconomics,
vol. 13 (January), pp. 333-72.
8
See Paul A. David (1990), "The Dynamo and the Computer: An Historical Perspective on the Modern
Productivity Paradox," American Economic Review, vol. 80 (May), pp. 355-61.
9
The relationship between competition and innovation is complicated and a matter of some debate. See
Philippe Aghion, Nick Bloom, Richard Blundell, Rachel Griffith, and Peter Howitt (2005), "Competition
and Innovation: An Inverted-U Relationship," Quarterly Journal of Economics, vol. 120 (May), pp. 701-
28. In addition, see the discussion of the literature in Rachel Griffith and John Van Reenen (2021),
"Product Market Competition, Creative Destruction and Innovation," CEPR Discussion Paper No.
DP16763 (Washington: Center for Economic and Policy Research, November).
10
See Ryan Decker, John Haltiwanger, Ron Jarmin, and Javier Miranda (2014), "The Role of
Entrepreneurship in U.S. Job Creation and Economic Dynamism," Journal of Economic Perspectives, vol.
28 (Summer), pp. 3-24.
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employment. If manufacturing were to return to its role as a productivity leader,
productivity for the total economy would grow noticeably faster.
Looking ahead, productivity plays an important role in our thinking about the
outlook. Productivity growth raises the nation's per capita income and, one hopes, the
welfare of the typical household. As I mentioned earlier, productivity growth may also
help lower prices. If we can make more with less, firms can lower the cost of the final
product and still remain profitable. For this reason, it is heartening to see all the
innovation happening in the motor vehicle industry and throughout the economy. It is
hard to know exactly when all the benefits will show up, but we know the historical
evidence suggests they are coming.
Policy Implications
What does all this mean for monetary policy? Innovation and productivity growth
undergird our long-term growth prospects, but they have only an indirect link to current
inflation developments. More broadly, the auto sector and manufacturing overall serve as
a microcosm to observe many factors buffeting the economy and impacting consumer
prices, such as bottlenecks and labor shortages. Notwithstanding some easing of these
pressures on goods prices, services prices continue to rise briskly. Altogether, inflation is
still unacceptably high and must be our primary focus.
The Federal Reserve has taken significant steps to rein in price increases. Since
March, the Federal Open Market Committee (FOMC) has raised its policy rate nearly 4
percentage points, an unusually rapid pace of increases that has significantly tightened
financial conditions. That tightening is clearly slowing demand in sectors that are interest
sensitive, especially housing, with residential investment contracting sharply. Consumer
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spending has remained resilient, however, supported by labor income growth and still-
elevated savings.
As we said in the most recent FOMC statement, we anticipate "ongoing increases
in the target range will be appropriate in order to attain a stance of monetary policy that is
sufficiently restrictive to return inflation to 2 percent over time."11 What policy rate is
sufficiently restrictive we will only learn over time by watching how the economy
evolves. Given the tightening already in the pipeline, I am mindful that monetary policy
works with long lags. Thus, as we get closer to that uncertain destination, it would be
prudent to move in smaller steps. How far we go, and how long we keep rates restrictive,
will depend on observed progress in bringing down inflation. But rest assured, we will
keep at it until the job is done.
Thank you.