Productivity Boom—New Dawn or False Dawn?

Franklin Fixed Income CIO Sonal Desai discusses why the recent acceleration in productivity growth might prove durable, leading to higher potential returns on real investment and a higher equilibrium interest rate.

US productivity growth accelerated sharply over the course of 2023. Financial markets have been paying close attention to various measures of inflation, wage growth, gyrations in employment and unemployment, and consumer and business confidence. But I think productivity might turn out to be the most intriguing and important economic development and warrants closer attention.

Productivity tells us how much an economy can produce with a given level of resources. Labor productivity, in particular, tells us how much an economy’s workforce can produce given the level of capital stock and technology available. Stronger productivity growth drives faster improvements in per-capita incomes and living standards. It also has an important impact on financial markets—a dollar invested in real economic activity has a stronger return. Other things equal, this should translate in stronger equity market performance.

Faster productivity growth also means greater real investment opportunities and a corresponding higher demand for capital, and therefore typically results in a higher equilibrium (or “neutral”) rate of interest, the famous “r*”. This is confirmed by the chart below, which shows a close correlation between productivity growth and the estimated neutral interest rate.

US Productivity Growth and the Neutral Rate