E C O N O M I C R E P O R T O F T H E P R E S I D E N T

ic growth, with positive effects on the Federal budget balance; and it hasboosted stock market valuations.Over the past 4 years, the income-side measure of output, gross domesticincome, has grown half a percentage point per year faster than the productsidemeasure, gross domestic product. Because measurement error enters intoboth, the Council of Economic Advisers believes that we learn somethingfrom each, and therefore the following discussion focuses on an average of thetwo measures in discussing trend productivity and potential output.What Has Caused Productivity Growth to Rise?Because the apparent acceleration in productivity is less than 4 years old, itscause and future continuation remain controversial. A year ago, available datashowed productivity growth to be within the range of normal cyclical variation.But more recent data, especially the October benchmark revision to the nationalaccounts (Box 2-3), place the acceleration on more solid footing. Nationalaccounts revisions result from changes in price measurement and new definitionsas well as the arrival of new data. Abstracting from the first two, the databasedrevision over 1995-98 allows us to advance the start of the acceleration atleast to 1997 and perhaps as early as 1995. And insofar as the revised data aremore accurate, they make the identification of the acceleration more credible.The Council’s analysis finds that two developments account for half of thisacceleration: an increase in capital—especially computer and software capital—and productivity growth in the computer-producing sector.Labor productivity increases when workers have more capital to work with.Capital deepening has been a persistent feature of the U.S. economy sinceWorld War II, as capital services per hour has increased in almost every year. Yetin 1995, business investment as a share of GDP climbed above its long-termaverage, and it has continued upward since. As a result, capital services per hourgrew faster after 1995 than before. Estimation using preliminary data andestablished methods of growth accounting (that is, weighting the growth rateof capital services per hour by capital’s cost share) finds that capital deepeningaccounts for 1.53 percentage points of annual labor productivity growth duringthe 1995-99 period. This is up from 1.06 percentage points during the1973-95 period (second line in Table 2-3). The difference between thesegrowth rates shows that capital deepening accounts for 0.47 percentage pointof the 1.47-percentage-point acceleration in productivity after 1995 (Table 2-3, column 3). Investment in computers and software accounts for all of thisgain from capital deepening. (Official data on capital services will not bereleased until mid-2000, and so these calculations remain tentative.)This contribution from capital deepening is important, but it is not thewhole story. Although capital deepening contributes to labor productivitygrowth in the long run, it has not been a reliable guide to year-to-year fluctu-80 | Economic Report of the President