Labor productivity has been growing steadily. The trade war could undo that progress.
One of the most promising trends in this economy over the last few years has been strong productivity growth; labor productivity has been growing for two years now, and last year it was especially strong.
That’s important because it means we’re taking fewer hours to make more stuff — or do more stuff, in the case of services, which make up more than two-thirds of this economy. Productivity growth can help businesses afford to increase workers’ pay. It can keep a lid on inflation. And in the long run, it drives economic growth.
But President Donald Trump’s trade war, and an economic slowdown this year, could undo that progress. And if productivity stalls, the economy could suffer in the long run.
One of the reasons that productivity growth has been so strong recently is that unemployment has been low. Preston Mui, a senior economist at the research group Employ America, said when the labor market is tight, workers feel empowered to find better jobs.
“They move from lower paying jobs, to higher paying jobs, lower productivity jobs, to higher productivity jobs,” Mui said.
Mui said rising wages incentivize businesses to buy equipment, so they can boost output with less labor. Higher wages are also a good sign for consumer demand.
“This encourages businesses to say, ‘Well, if I think that demand is going to be robust in the future, I’m more confident about making investments that might be more forward-looking,’” he said.
But Mui said the trade war is putting all of that at risk. If it causes a recession, unemployment will rise, and workers won’t be able to find better jobs. Meanwhile, it already has businesses holding off on making investments.
“They aren’t building factories, they aren’t purchasing equipment, they aren’t engaging in these longer-term research and development projects, and all of that is going to be a drag on productivity going forward,” Mui said.
Companies that are more productive are also insulated from having to raise prices themselves, because higher productivity helps them become more profitable. That means they can afford to take the hit to the bottom line.
But Peter Orazem, an economics professor at Iowa State University, said that could change if productivity growth slows down while the President’s tariffs push up prices.
“Then, we’re going to have a much more serious inflationary problem than we would have just from the tariffs alone,” Orazem said.
There’s another threat to productivity growth in the long run.
“I think at the core, innovation is at risk,” said John Haltiwanger, an economics professor at the University of Maryland.
Haltiwanger said the Trump administration’s cutbacks and funding freezes to higher education are already adversely affecting research. They could also cause universities to admit fewer students and produce fewer graduates, which would restrict the pipeline of future innovation.
“In many ways, this may be the most adverse impact on productivity,” Haltiwanger said. “You’re attacking, literally, the core of science and R&D in the U.S.”
Volatility in financial markets is another threat. That could make lenders less willing to support risky startups, which threatens the entrepreneurship boom we’ve seen since the pandemic. Haltiwanger said new and innovative businesses tend to boost productivity.
“Many of the things they try don’t succeed, but if they do, oftentimes it’s a more radical innovation, and it’s those radical innovations, those things that really change the way we do business, that have enormous value,” he said.
Haltiwanger said research, innovation and productivity growth boost economic welfare over time: our incomes, what we’re able to consume, and how we communicate — in other words, our standards of living.
So if productivity growth slows down, “you’re going to slow down the growth in the standard of living, full stop,” he said. “Standards of living and productivity go hand-in-hand.”
If productivity stalls this year, Haltiwanger said the economy will feel the effects for decades.