Capital Markets Update #5

It’s not unusual to think of productivity as a relatively interesting but somewhat opaque reference to “good things” happening within the economy.  The truth is, if that’s your view, you’re certainly not wrong.  That said, it’s our contention that productivity may just deserve more of your consideration, for the power productivity growth brings to an economic engine is real and dramatic.  We track the measure quite closely.  If entrepreneurship is the fountain of youth for an economy, productivity would be its Slim-Fast. 

There are a few ways by which to measure productivity.  The most widely consumed measure would be labor productivity or total output divided by total number of labor units inputted.  According to the BLS, third quarter 2025 labor productivity touched 4.9% on an annualized basis, as real total output increased at a 5.4% rate (annualized) against a 0.5% increase in total hours worked.  Only one other datapoint (Q3 2023 – 5.3% annualized productivity) compares since the GFC, stripping out Covid idiosyncrasies.

This is a fantastic reading for the US economy, but Labor productivity is a relatively narrow view of actual efficiency.  We tend to focus on what’s known as multifactor productivity, as represented by total output divided by an amalgamation of total inputs including land, labor, capital (both human and monetary) and technology.  You can’t really put a number on it, you almost have to estimate it using labor productivity as the keystone datapoint; but, multifactor productivity is a decent prism through which to compare states of productivity across points in time or various subjects (economies, for instance).  As an example, you might feel better about a 4.9% labor productivity growth rate today than a 5.3% growth rate in 2023, given today’s tangible growth in compute and associated application of AI.  You couldn’t capture that takeaway from the labor productivity measure alone. 

The ”so what” in all of this is as US birthrates continue to stagnate, immigration ceases and we pressure our existing natural resources (lets just call that available land, for the purposes of this discussion), you start to understand how the long-term health of the US as a functioning society is actually quite levered to this incredibly powerful productivity force.  For instance, you could feasibly continue to create GDP per capita by constantly expanding horizontally at a marginally efficient pace. In that scenario, our future world would look something like a Sci-Fi movie, represented by endless fields of dilapidated carcasses of used resources and little present value to show for it.

Here's an interesting comparison - let’s compare the US, Europe and Chinese economies.  The US has a ton of land, labor, capital and technology. Collectively, our economy invests these assets as best it can to produce GDP and we do it arguably better than anyone else (see note on China below).  The more successfully we do these things, the higher the productivity growth rate, which allows businesses to drive margins and create equity expansion.  Voila – 100% return on the S&P 500 in the last 5-years.  For reference, annual labor productivity growth in the US has run at a 2.0% trend since Q4 2019, according to the BLS.

Europe, by comparison, is relatively land constrained for an export-driven economy (50% of EU GDP comes from exports according to World Bank), self-limits its technological adoption and invests disproportionately on welfare programs.  The EU is approximately 1.6MM square miles in size vs 3.8MM in the US. However, the EU houses, by comparison, 450MM people across that tight footprint vs 340MM in the US.   Technological adoption is a difficult metric to measure, but access and use are entirely separate principles.  For instance, one could argue the EU has access to the same technology as the United States and develops comparable human capital through its educational system.  However, clearly the collective European economy fails to utilize its available capital and technology as efficiently as, say, US businesses do.  The collective European governments’ burdensome regulatory regime and social investment focus foots much of the blame here.  Ultimately, the EU has seen approximately 0.1% annual productivity growth, on trend, since 2021 according to Bain.  This follows an anemic 0.6% productivity growth trend during the years 2000 – 2019.   In effect, the EU needs excellent and efficient capital and technological deployment to maximize productivity given its per-capita land density constraint and inability to simply expand horizontally to create new exports at will.

China represents the polar opposite scenario.  China is exceptionally land and labor rich, and has recently developed a capital war chest and technological capability to match.  According to internal government stats, China reported pretty steady ~7% labor productivity growth from 2013 – 2019 and 5.8% productivity growth most recently.  But define output.  China has built dams and roads and trains and homes (so many homes) and factories and companies and on and on and on…that nobody uses or will ever use.  To put this into perspective, imagine if the US government took the $4.7 trillion it spends annually on healthcare, social security and social assistance programs (2024 Center for Budget and Policy Priorities data) and pushed it into building stuff, then called that stuff output.  China is able to do this because of its lack of land constraints and, in some ways, very efficient capital deployment regime.  They can literally choose exactly where the money will go and send it there.  Analyzing the internals of the Chinese economy and whether this capital deployment regime into “fake output” will ever come to roost economically is a great topic for another week.  Regardless, when the cost of land and labor is near zero, you can manufacture output pretty efficiently if you continue to invest enough capital through a continually improving manufacturing processes.  This particular paradigm crumbles, however, when you run out of land, labor or capital.  The first two are unlikely to happen in China, the third very well might.

In conclusion, we should be incredibly supportive and proud of the recent uptick in domestic productivity. Provided we can maintain a strong productivity growth rate, our US economy could feasibly expand at an above-trend pace without generating above-trend inflation.  Most importantly, we appear to be generating multifactor productivity via a relatively balanced initiative across the various inputs.  We’re deploying more capital, utilizing (but not over-utilizing) our natural land resources, to create output through the application of innovative technology developed by a generational human capital factor.