EXPLAINING INDUSTRY LABOR PRODUCTIVITY MOVEMENTS

I. INTRODUCTION The 1970s marked a significant turning point in the postwar productivity performance for industrialized economies: robust productivity growth disappeared and several decades of low growth followed. This phenomenon was perhaps most pronounced in the United States. Figure 1a shows that labor productivity displays a clear slowdown beginning in the mid to late 1960s. The figure plots data for log average labor productivity measured as real GNP per full time equivalent employee.(1,2) Trends in log average labor productivity have varied across U.S. industries, as shown in Figure 1b. Productivity in the manufacturing sector has been comparatively stable in both durable and nondurable goods. For durable goods there was a slight slowdown in the mid and late 1970s, but the mid 1980s marked an upturn in productivity performance. Agriculture, trade, finance, insurance, real estate, and services, on the other hand, reflect the dramatic halt in labor productivity growth that is evident in the U.S. aggregate data. Mining and construction display the most dramatic declines in labor productivity across industries. This paper investigates the importance of three shocks at the industry level for explaining industry labor productivity movements; industry demand shocks, supply shocks, and labor supply shocks. Past studies have attempted to quantify the contribution of changes in factors of production, technology, education, and other supply side variables in explaining the productivity slowdown, typically using a growth accounting framework, e.g. Denison [1979]. This paper instead investigates the importance of traditional notions of demand and supply shocks in explaining productivity movements. The results show that demand shocks, as defined in the paper, are not important in explaining labor productivity movements. Supply shocks, on the other hand, have immediate and long lasting effects. This suggests that theories of demand driven productivity movements are not consistent with the data. These results confirm work by Shapiro [1987a], who showed that the Solow residual in U.S. aggregate and industry data accurately reflect supply shocks. This paper adds to Shapiro's results in two important ways. First of all, supply shocks are broken into productivity shocks and labor supply shocks. Also, the impact and importance of these shocks relative to demand shocks are estimated directly. The evidence shows that labor supply shocks are important for explaining labor productivity movements, particularly in trade and services. Positive labor supply shocks are associated with persistently declining labor productivity. The two decades beginning in the 1970s saw dramatic shifts in the employment distribution across U.S. industries. As Table I shows, employment in trade and service industries expanded while the share of employment in manufacturing declined. The timing of the productivity slowdown in trade and services is coincident with these changes in the employment distribution. The results in the paper suggest that the increase in labor supply that these industries experienced is a main factor explaining their slowdown in labor productivity. Of course, others have examined the effects of employment movements on labor productivity. For example, Mincer [1991] provided evidence that the influx of inexperienced workers has made on the job human capital formation more difficult and has thus led to a decline in labor productivity. In addition, Helliwell, Sturm, and Salou [1985], Englander and Gurney [1994], Romer [1987], and Perloff and Wachter [1980] have all shown that increased employment growth is associated with declining labor productivity. Darby [1984], Baily and Gordon [1988] and Jurgenson, Gallop, and Fraumeni [1987] have pointed to declining labor quality as a factor behind the productivity slowdown. All of these studies confirm the negative correlation between employment growth and productivity and attribute some of the productivity slowdown to rapidly increasing employment. …