The Independent Market Observer

6/28/13 – Productivity and the Deficit

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Jun 28, 2013 6:17:44 AM

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Not a lot of urgent economic news today, thank goodness. The recovery continues, with more good news and an increasing percentage of data points coming in above expectations. The Fed continues to emphasize that it has not and will not pull back in the immediate future, and stock markets are responding.

So, in the face of all this good news, let’s go looking for more. Today, I want to talk about productivity, structural changes in service provision, and how that can start to work to alleviate some of the deficit problems we’ll be facing in the next 20 years.

One of the principal tailwinds to corporate profits over the past couple of years has been the growth in productivity. Put another way, companies have laid off many people and done more with less labor. They accomplished this through a mix of working the remaining employees harder and by being more efficient.

Many industries can do this, but two very big ones, education and medical care, have resisted such productivity gains. Doctors and teachers can only deal with so many people effectively per day. In the jargon, their services are not scalable. You can’t get more out without putting more (doctors or teachers) in.

By no coincidence, these industries have also been two of the ones in which costs have been least controllable. While other industries—computers, cars, music—have become more efficient and invented new business models, education and medical care have remained with their old, one-on-one or one-on-a-few model.

This isn’t to blame these two industries specifically. The problem is endemic to service industries, and one of the biggest challenges for companies has been to figure out how to maintain service and quality levels while cutting the actual people component.

Technology has been a huge part of this, with good results (I can’t imagine dictating this post to a secretary, for example, rather than typing it myself) and bad (endless corporate voicemail trees). Applying technology to education and health care has been hard so far, and we haven’t seen the productivity gains that allow lower cost growth.

So far, anyway, but there are signs that may be changing. The reason I singled out health care and education among service industries is that they matter at a national level. Health care is one of the principal drivers of the deficit in the form of Medicare, which will only become more important in the next couple of decades. Education and student loan costs will make or break the ability of workers—and the economy—to continue to make real gains. Doing a better job with these two sectors may determine whether we succeed as a country in the next 50 years.

Both of these industries warrant a more detailed discussion, which I will tackle next week, but briefly, the points are as follows. Health care costs have grown unbelievably over the past 50 years, but the rate of change has actually been slowing and recently rolled over. Studies of other industries have found that it can take decades for new technology to make meaningful productivity differences—and they seem to be showing up on about that schedule in health care. Good news.

The same applies for education, but in a different way. While the actual observed cost inflation hasn’t downshifted, the availability has increased sharply, thanks to technology. I suspect the statistics haven’t yet caught up with the reality, due to measurement difficulties.

Both of these areas merit more complete discussion and will get it next week. But as a takeaway for the weekend, the news is good. Have a great weekend!

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