How to Escape the Productivity Slump
Removing policy barriers can unleash a new era of productivity and abundance.
by Jeremy Horpdahl
In a previous exploration of the housing affordability crisis, I observed a sobering reality: artificial scarcity is often a policy choice. We have placed arbitrary limits—mostly through local governments—on our ability to build homes, driving up costs and restricting opportunity. But this pattern of self-imposed constraint does not stop at the edges of our neighborhoods. It extends into the institutions and policies that shape economic growth. It is one of the primary reasons why, despite living in an age of extraordinary digital innovation, we remain stuck in a decades-long productivity slump.
Economists often measure technological progress using a concept called Total Factor Productivity (TFP). In simple terms, TFP measures how efficiently an economy turns labor, land, and capital into goods and services. When TFP rises, society discovers better ways to produce more with the same resources.
From the 1920s through the early 1970s, TFP in the United States and much of the developed world grew at more than 2 percent per year. This was the era that gave us commercial aviation, widespread electrification, antibiotics, and the Apollo program. The physical world was transformed in a single generation.
Since the early 1970s, however, productivity growth has slowed dramatically to less than 1 percent in most years. As investor Peter Thiel famously quipped, “We wanted flying cars; instead, we got 140 characters.” Digital technologies have advanced rapidly, while progress in energy, transportation, infrastructure, and advanced manufacturing has been far slower. We can send vast amounts of information across the globe in milliseconds, yet we often struggle to build major infrastructure projects on time or on budget.
A 2020 paper by Nicholas Bloom and co-authors argues that good ideas are getting harder to find – that is, more investment in research and development has become necessary for each new patentable idea. However, more recent research by Teresa Fort and co-authors (currently in working paper form) suggests that this is not the case. The Bloom et al. result may, in fact, be an artifact of focusing on manufacturing firms, which were dominant from about 1970 to 1990. Fort and her co-authors show that patenting and innovation have shifted in recent decades, becoming dominated by firms in information, management, and professional services.
Because manufacturing is a physical process, it is much more likely to be subject to, for example, environmental regulations, whereas an IT firm operates in a much less regulated sector. So, our relative stagnation may not be the result of a scientific drought after all. Universities and research laboratories continue to produce remarkable discoveries. We are not failing at invention; we are failing at diffusion, the process of turning new discoveries into widely used products and services.
The Diffusion Deficit and the Permitting Veto
Innovation does not benefit society until it escapes the laboratory and enters the marketplace. The journey from a peer-reviewed paper to a consumer-ready product is long, expensive, and uncertain. Over time, policymakers have added layer upon layer of regulatory complexity to that journey.
Physical innovation requires physical construction. New technologies need testing facilities, advanced laboratories, semiconductor fabrication plants, energy infrastructure, and transportation networks. Yet building almost anything of significance in the modern West often requires navigating years of environmental reviews, public-comment periods, and multi-agency approvals.
Laws such as the National Environmental Policy Act (NEPA) and state-level counterparts such as the California Environmental Quality Act (CEQA) were originally intended to prevent environmental harm. Over time, however, they have increasingly become tools for the delay of progress. Because these laws frequently allow opponents to challenge projects on procedural grounds, they have contributed to what political scientist Francis Fukuyama calls a “vetocracy”—a system in which many actors can block decisions but few can make them. Average NEPA environmental impact statements now take almost four years to complete, with many extending far beyond a decade. Thankfully, the median is a bit shorter, but still about 2.5 years.
Consider the recent push to reshore semiconductor manufacturing. While the government has allocated billions of dollars in subsidies to build these vital factories, the physical construction is bottlenecked by years of permitting and environmental reviews. A state-of-the-art fabrication plant (commonly called a “fab”) that takes 18 months to build in Taiwan or South Korea can take three to five years just to obtain a permit in the United States.
The result is predictable: projects take longer, cost more, and become less attractive to investors. Even when governments provide subsidies for strategic industries such as semiconductor manufacturing, years of permitting can slow implementation. Time is money, and prolonged regulatory uncertainty discourages investment in capital-intensive industries.
The solution is straightforward, even if politically difficult. Critical infrastructure, advanced manufacturing facilities, and research laboratories should face streamlined approval processes. If projects satisfy clearly defined environmental and safety standards, they should be approved in months rather than years.
Pull Mechanisms: R&D Prizes and Commercialization
Reducing regulatory barriers is only part of the solution. We must also rethink how innovation is encouraged and financed.
In addition to corporate financing, most governments try to support innovation through “push” funding. Researchers receive grants to conduct experiments, purchase equipment, and explore new ideas. This model, some economists argue, can be effective for basic science, especially when commercial applications may be years away.
Commercialization presents a different challenge. Many promising technologies fall into what innovators call the “Valley of Death” – the difficult period between a successful laboratory demonstration and a commercially viable product. At this stage, development costs rise sharply while uncertainty remains high.
That is where “pull” mechanisms become valuable. Instead of paying for research inputs, policymakers reward successful outputs. An Advance Market Commitment (AMC), for example, guarantees that a buyer will purchase a product if it is successfully developed. Rather than funding every possible approach, the sponsor commits to paying for results.
Economist Michael Kremer helped pioneer this approach through vaccine development programs. More recently, Operation Warp Speed demonstrated its effectiveness. The government did more than fund vaccine research; it guaranteed large future purchases for successful vaccines. By reducing market risk, policymakers encouraged firms to accelerate development and manufacturing simultaneously. The result was one of the fastest vaccine-development efforts in history.
Consider other approaches. Throughout history, prizes have also stimulated innovation. The Longitude Prize helped solve a critical navigation problem for maritime trade, while the Ansari X Prize helped launch the private spaceflight industry. Pull mechanisms align private incentives with public goals by rewarding success rather than political connections or grant-writing skill.
Breaking Local Monopolies and Regulatory Capture
When people hear the word “monopoly,” they often think of large technology companies. Yet some of the most significant barriers to innovation exist at the local level.
The electric utility sector provides a clear example of how regulatory design shapes technological adoption. Because most utilities operate as regulated monopolies with government-guaranteed rates of return on capital investments, their business model relies on continuous, large-scale infrastructure growth.
Put simply, utilities make more money the bigger power plants and power lines they build, so they usually prefer huge projects over things like rooftop solar panels that let people generate their own power without the utility having to build as much infrastructure.
Decentralized energy technologies—such as local battery storage, micro-grids, and advanced management software—directly threaten this model by optimizing the existing grid and reducing the need for new capital projects. As a result, studies from the MIT Energy Initiative and industry financial analysts indicate that utilities frequently leverage legacy regulatory processes to delay or block these decentralized innovations from integrating into the wider network.
Similar dynamics exist elsewhere. State dealership franchise laws frequently restrict direct-to-consumer automobile sales, making it more difficult for new manufacturers to enter the market. Occupational licensing requirements now affect roughly one-fifth of American workers and can create barriers to entry that limit competition and labor mobility.
Innovation depends on what economist Joseph Schumpeter called “creative destruction” – the replacement of older, less efficient business models with better ones. When established interests use regulation to shield themselves from competition, they slow technological adoption and reduce future productivity growth. Encouraging competition and reducing regulatory barriers at the state and local level would help accelerate the diffusion of new ideas throughout the economy.
Choosing Abundance
The productivity slowdown is not an immutable law of nature. It is, at least in part, the consequence of policy choices. Human ingenuity remains as powerful as ever. We have more scientists, more capital, and better tools than any previous generation. The challenge is not generating ideas; it is allowing those ideas to spread.
By streamlining permitting processes, expanding the use of R&D prizes and Advance Market Commitments, and reducing barriers created by protected local monopolies, we can accelerate innovation in the physical world.
An additional one or two percentage points of annual productivity growth may sound insignificant. Yet when compounded over decades, the effects are transformative. Higher productivity means higher incomes, better health outcomes, more abundant energy, and greater opportunities for future generations. The ideas already exist. The question is whether we will allow them to flourish.
Author: Jeremy Horpedahl, the Director of ACRE and an associate professor of economics at the University of Central Arkansas.
Worked for 31s
A persuasive case that removing policy barriers can unleash human ingenuity, investment and innovation. But what role does optimism play in productivity growth? Reform depends not only on better rules, but also on people believing improvement is possible, seeing opportunities worth pursuing and having the confidence to invest, innovate and act.