gains. but i suspect that longer - term, structural changes, reflecting the boom in capital spending and the revolution in information technology, probably have been more important. i will return to the evidence of this point shortly. why are the growth rate of productivity and the sources of that growth so important to policymakers? very simply, economic theory indicates that, over the long run, faster growth of labor productivity allows faster growth of real wages - that is, wages adjusted for inflation. without faster growth in productivity, businesses faced with a nominal wage bill that is increasing faster than productivity would be tempted to pass those increased labor costs to consumers in the form of higher prices for goods and services in order to protect profit margins. adding the growth rate of labor productivity, or output per hour, to the growth rate of the number of labor hours gives an approximation of the rate of increase in the economy ’ s ability to create goods and services. since labor hours tend to be determined in the long run by increases in the working - age population, growth in productivity is the focal point. why then are the sources of productivity growth important? if that growth in productivity is due to a change that outlasts the business cycle, then economists and policymakers can have confidence that the productive potential of the economy has changed. economists speak of that as “ trend ” productivity and the resulting growth rate as the “ trend ” growth rate. the structural changes that i mentioned above have had effects beyond increasing the rate of productivity growth. they have also enhanced the ability of businesses to reduce their operating expenses. in many industries, investments in information technologies have helped firms to cut back on the volume of inventories that they hold as a precaution against glitches in their supply chain or as a hedge against unexpected increases in aggregate demand. in fact, we have seen that the ratio of inventory to sales and inventory to shipments have both trended down since 1995. product development costs have probably also been reduced through the use of better computer hardware and software, and new communications technologies have increased the speed with which firms can share information - both internally and with their customers and suppliers. this intense focus on cost reduction has been an important element in helping to head off the development of inflationary pressures in this expansion. moreover, given intense competition and the resultant lack of pricing “ leverage ”, ongoing programs to reduce costs have become a key part of corporate strategies to maintain or improve profit margins. technology change and productivity growth bob solow - the mit economist

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