Production Junction; Market Functions

A lot of economic theory deals with creating value, which we can loosely define as the value of an activity leftover after subtracting from it the cost of doing it (and if you want to get technical, also the opportunity cost of not undertaking an alternative activity). More value should mean higher profits and higher stock prices. Often that's achieved in the corporate world by sheer top-line growth and the economies of scale that go along with increased sales volume. Analysts and media tend to focus on those. But another way to create value in an economy is through productivity gains.

Productivity is the amount of output created (in terms of goods produced or services rendered) per unit input used. For instance, labor productivity is typically measured as output per worker or output per hour. Companies can increase productivity in a variety of ways—the most obvious being increased automation and computerization. Increases in productivity don't just drive corporate profits, they also can improve living standards and lead to higher income for employees.

For most mature industries that don't have big sales growth, increases in productivity are one of the only ways to drive value creation. Specifically, lots of mature Consumer Staples companies, which can only grow revenues at about the rate of GDP, employ new methods of distribution, manufacturing, marketing, and even management structures—all to get more out of each dollar spent.

Ok, enough with the economist-speak. Now for some market-speak.

A widely held misconception about productivity is that it's mean reverting. The story goes that since we've seen such big productivity gains (particularly in the 90s), it should eventually either come way down or turn negative to "even out" the long term growth rate.

The fact is productivity gains have been consistently positive, particularly in the US, going back as far as we can get reliable data (about 1950). Many things are mean reverting in financial markets and economics, but not all things. The steady value creation from productivity is a reflection of innovation, competition, and tremendous breakthroughs in technology. These are all things a free, democratic and capitalistic society are good at, and also a good reason stock markets consistently appreciate. There's no reason it has to stop.

Here are some real-world examples:

Productivity Pays Off For Caterpillar

By Staff, CBS News

Is the US really losing the manufacturing war to other countries? "Last year, America produced $1.79 trillion worth of goods, almost twice as much as second-place Japan… The key to success in factories like Caterpillar comes down to one thing: A steady growth in worker productivity. In other words, it's not your grandparents' assembly line."

Cable Rate Increases Are Smallest in Years
By Sarmad Ali, The Wall Street Journal
https://www.wsj.com/articles/SB116545684557642954

The effects of competition finally entering the video media markets are driving lower prices, better efficiency, and more services to the consumer.

Japan's Population Fall a Case for Freakonomics?
By William Pesek, Bloomberg

"Boosting innovation and productivity is the only way high-cost Japan can maintain its living standard amid the rise of low-cost China, India and Southeast Asia."