What’s (not) up with productivity growth? A quick overview

August 22nd, 2017 at 11:35 am

For a long while now, I’ve been thinking and reading about the great productivity growth slowdown, so it seemed like a good time to give the lay of the land as I see it:

–Facts of the case, 1: As measured (as you’ll see, this caveat is important), since 2010, output per hour has been growing about 1% per year, half the growth rate of the long-term average. Slowdowns of similar magnitudes have occurred across most advanced economies.

Source: Furman, https://www.vox.com/the-big-idea/2017/3/21/14938698/growth-trump-economic-us-slowdown-demographics-stagnation

–Facts of the case, 2: The bulk of the slowdown is attributable to a decline in total factor productivity (TFP), or the growth in output when you take out all the measurable inputs. TFP is reasonably considered a proxy for innovation.

–The dreaded “empty hole problem:” Outside of accounting exercises that raise as many questions as they answer, economists do not understand the underlying forces that make productivity speed up and slow down. This creates the “empty hole problem:” since no one knows the answer, partisans fill the hole with their favorite candidate. E.G., here in DC “tax cuts and deregulation!” become the solution du jour.

–Optimists and (sort of) pessimists: When it comes to how lasting our plodding productivity growth rates will be, commentators fit roughly into pessimistic and optimistic camps. The pessimists are the larger group and, at least in my judgement, have better evidence. Their focus is on the slowdown in TFP, and for all the talk about it, no one really knows what drives innovation cycles. In that sense, “who knows?” is a subgroup among the pessimists wherein I place myself. The real pessimist caucus is chaired by the productivity expert Robert Gordon, who argues that the big-ticket productivity movers—e.g., electricity diffusion, air conditioning, indoor plumbing, air travel—are long behind us. Candy Crush is a fun, free diversion, but it ain’t a big efficiency play.

–What about mismeasurement? The optimists largely depend on mismeasurement and they bring some evidence to the table. Since we’re talking about growth rates, showing evidence of mismeasurement alone is not proof of anything. It must be shown that mismeasurement is getting worse, i.e., that we’re increasingly leaving out value added in our measures of real output. Some mismeasurement claims stem from the observation that sectors wherein it is harder for national accountants to pick up true declines in quality-adjusted prices—health care, software, the “app” economy—are the very sectors that are growing as a share of value added, meaning even constant mismeasurement in those sectors could lead to downward bias in measured output and thus productivity.

The biggest mismeasurement advocates are the typically hard-nosed economics team at Goldman Sachs. The figure below shows their portentous adjustments to output from significantly goosing the quality adjustments to IT hardware, software, and “free digital content.” Based on this work, they conclude that both GDP and productivity growth are understated by 1/4-1/2 percentage points, which is big in this biz.

Source: GS Research

However, I don’t find all their adjustments fully convincing. Careful research points out that we’re doing a better job than we used to measuring hardware and software, thus the productivity slowdown may be understated (in the US, we’re also producing less IT hardware). Other work finds that, yes, our price indices are missing tech improvements, such that TFP in that sector has hardly slowed at all. But this just implies that TFP outside of tech has decelerated even faster than we thought. Then there’s research showing that productivity is falling across many countries, and its decline is uncorrelated with their production of IT.

Also, a bunch of what’s allegedly being increasingly mismeasured – e.g., the value of software – are intermediate goods, meaning you’ve got to show the links in the chain such that final demand is increasingly biased down.

Wherein I fill the empty hole: Here are three explanations that make sense to me. First, some of the most interesting research in this space shows an historically unique divergence between the productivity growth of so-called “frontier” and “laggard” firms. Why has the latter failed to adopt the technologies of the former, and why hasn’t that failure led to their demise? This may be an important market failure.

Second, though the productivity slowdown predates the Great Recession, “secular stagnation” has been upon the land for quite a while now, and thus it might be a mistake to reject the hypothesis that weak demand is a factor. I can think of a simple, intuitive model wherein strong demand boosts unit labor costs, squeezing unit profits, such that maintaining profit margins means finding ways to produce more efficiently (this is the “full employment productivity multiplier” about which I’ve theorized). Third, the most accurate forecasts of productivity growth over the next few years require the use of very long—as in 40 years—autoregressive lags, so perhaps we will eventually mean-revert back to healthier productivity growth rates.

That last point is in the spirit of the most honest answer: who knows?

Quick note on inflation, exchange rates, and wages

August 18th, 2017 at 11:28 am

A few weeks back, I did some simple modelling of the impact of the weakening dollar on US inflation, suggesting it would boost price growth a bit, but was nothing to get wound up about. And, of course, a little more inflation would be welcomed.

Researchers at Goldman Sachs took an interesting, deeper dive into this question (no link). They came up with the same qualitative answer—a modest bump, not a big increase. In fact, they show that the actual impact on inflation of the dollar’s appreciation, 2014-16, was about half of what would be predicted by conventional models.

What’s changed to dampen the elasticity of the overall price index to import prices?

First, though this just labels the question posed above, the pass-through of dollar/exchange-rate changes to import prices has fallen from 60 to 25 percent. There’s a hint in the figure as to why this occurred. That big drop in the exchange rate pass-through in the latter 1990s coincides with the Asian financial crisis, which led to a sharp downshift in pricing by Asian exporters, notably China.

Source: GS Research

The moral of this story is that one reason for the flattening of the price Phillips Curve is the increase in global supply chains and changes in export pricing. Prices are less responsive to exchange rates. Research has also found the wage-price pass-through to be considerably dampened. Put it all together, and one concludes that the dominant model of inflation is in ill-repair at best.

Whether that’s for now or for eternity is another question, but I’m pretty much with Larry Summers on this: “The Phillips curve is at most barely present in data for the past 25 years.”  Thus, the instincts of some on the FOMC to be patient with rate hikes right now looks theoretically and empirically warranted.

Remember Tax “Reform” (i.e. cuts)?

August 17th, 2017 at 10:36 am

“Really?! You’re complaining about regressive tax plans, now? Like that’s America’s biggest problem?!?”

Yes, I’m writing about ongoing plans for even-more-regressive-than-I-thought tax plans, based on some interesting, new analysis from the Tax Policy Center. And no, that’s not America’s biggest problem.

That would be the presidency in crisis. If it wasn’t clear to some from the start, it is becoming increasingly clear to many more, including the CEOs who signed up to advise the new president (which was never going to end well), that our president is not only incapable of uniting the country when he’s given the opportunity to do so. He cannot resist doubling down on tearing us further apart, and in the process, lending support to potentially and actually violent racists and anti-semites.

If I have any value-added in this space, however, it is in regards to policy. Obviously, a crisis in the executive branch interacts with policy in myriad ways. There’s the economic and social impact of foolish statements, like Trump’s off-the-cuff suggestion that military intervention in Venezuela is on the table. This served to prop up Maduro, prolong the ever-intensifying suffering of the Venezuelan people, and distance us from allies who were and are trying to help.

There’s the inability and unwillingness to deal with the many challenges we face: racial divisions, climate change, inequality, opportunity, public investment in people and physical capital (I kid you not: the Trump admin has dubbed this very week as “infrastructure week”), fiscal pressures, and the fundamental congressional dysfunction to address any of these, which of course, predated Trump, but which has increased. (To be clear, their inability to legislate their many harmful ideas is currently a feature of their dysfunction, not a bug.)

Their (Trump, Ryan, Brady) tax reform plans, from what we can tell, would exacerbate the problems of both inequality (most of their benefits go the wealthiest households) and insufficient revenues to meet the challenges listed above. And based on the new TPC study, once you factor in the eventual pay-fors, these plans are even more regressive than at first blush.

So, yeah. I’m writing about this stuff, in no small part because, trust me: the purveyors of these tax cuts are not sitting still. They’re actively working behind the scenes to pass this type of a plan, and while I definitely don’t want to lose sight of the bigger picture, I’m also happy to pull the curtain back on their efforts.

 

Are trade deficits good or bad? It depends!

August 15th, 2017 at 10:38 am

In light of this silliness in the WaPo today (which Dean Baker already jumped on), I’m compelled to repost this piece from a little while back, explaining why and when trade deficits are problematic and when they’re not.

Summarizing, it’s just as wrong to claim trade deficits of any magnitude are always a negative as that they’re always a positive. Like Neil Irwin said, motivating my earlier piece, “they’re not scorecards.”

When are they problematic? In two situations: first, when we’re not at full employment, and policy makers can’t or won’t make up the slack. The GDP identity–GDP=Cons + Inv + Gov’t spending + Trade balance–provides a simple way to show that a negative trade balance drags down growth.

Other components can make up the difference. However, in recent years, in periods of slack, the monetary authorities–central banks–have been increasingly likely to be stuck at zero on their interest rate, undermining their contribution to offsetting a trade deficit. And the fiscal authorities have been either stuck in austerity ideology (Europe), dysfunction, or both (that would be us).

The figure below shows that, in fact, trade deficits have been the norm over the period when we’ve been at full employment less than 30 percent of the time, so in this regard, our persistent trade deficits have been problematic more often than not in recent years. Note that I’m not drawing any causality here between trade deficits and the absence of full employment. My point is that the former (trade deficits) are more of a problem when we’re not at full employment and neither fiscal nor monetary policy is working to offset them.

Sources: BEA, BLS, CBO

The second way in which trade deficits are harmful is a bit more subtle. When we consume/invest more than we produce, we must borrow from abroad to make up the difference. On the other side of the ledger from the trade deficit is the “capital account surplus,” which simply represents the flow of capital into deficit countries to finance their spending beyond production.

The trade-deficits-are-always-and-everywhere-benign team argues that this is a feature, not a bug. Hey, if foreigners want to lend to us so we can spend more than we produce, that’s great!

But it’s only great if there are truly productive uses for the capital. If there aren’t, those flows can inflate…oh, I dunno…let’s say a real estate bubble. Or a dot.com bubble. See both Michael Pettis and Ben Bernanke on this point. No less a mainstream stalwart than the Lord Mervyn King, former governor of the Bank of England, recently held forth on the macroeconomic problems of persistent trade imbalances, linking them to countries that manipulate their exchange rates to preserve their trade surpluses (and therefore, other countries’ trade deficits; the system has to balance).

I think both of these conditions at which trade deficits are problematic–labor markets that are slack more often than not and the absence of productive investments–can be hard for people to wrap their heads around. We’re taught, against fact, that full employment is the natural state of affairs, and that productive investments are always there for the taking.

But especially in the age of financial engineering, where non-productive but potentially high ROI investment opportunities abound, that assumption just doesn’t hold.

What about now? We’re closing in on full employment so I wouldn’t invoke the trade deficit as a negative in that regard, though it took us too long to get here, due to the combination of the zero lower bound at the Fed, inadequate fiscal policy, and yes, the trade deficit, which has averaged -3.1% of GDP in this expansion.

On the investment side, if you believe we’re in a period of secular stagnation, which implies too much savings given desired investment (and remember, trade deficits occur when countries export their excess savings to us), then that’s a problem right now, putting downward pressure on interest rates, inflation, and demand. BTW, the logic of this suggests a smart solution to this part of the problem: investment in public infrastructure. On that, see dysfunctional Congress.

Finally, of course, our trade deficits are always in manufactured goods, so they invoke a sectoral problem for communities and families that depend on factory jobs. It is left as an exercise for the reader to connect the dots between that problem and our current political sh__show.

An important fact check on manufacturing value-added and employment

August 14th, 2017 at 4:33 pm

So, I’m driving around doing errands this past weekend when I hear former Secretary of Commerce Carlos Gutierrez (in GW Bush’s cabinet) interviewed about renegotiating NAFTA. He’s a big booster of the trade deal and wanted to make the point that any job loss in manufacturing was a result of faster productivity growth, not imbalanced trade. His evidence was as follows (my bold):

One of the things I go back to very often is our manufacturing as a percent of GDP. Our manufacturing output is pretty stable, pretty flat. If you go back 10, 15 years, it’s between 12 and 14 percent. But our manufacturing workforce has been declining steadily. So we’re producing the same output with fewer people. What that tells me is that technology is more of a threat to American jobs than trade.

Stable manufacturing output share of GDP?! I practically dropped the dry cleaning!

The first figure shows that, in fact, manufacturing’s share of output (blue line) has been falling since I was born in the mid-1950s. It was 11.7% in 2016, 13% in 2006, and 13.9% in the 2001. OK, that’s roughly between 12 and 14 percent, but it ain’t stable. It’s falling, and pretty steadily. In fact, Louis Uchitelle just published an important book on this long-term trend.*

Sources: BEA, BLS

The red line shows the decline in manufacturing employment, which is also steadily declining, such that the most we can determine from these trends is that we’re creating a smaller share of output with a smaller share of workers, as the scatterplot of the data in the two figures clearly reveals.

Sources: BEA, BLS

The employment share falls faster than the output share, so sure, there’s been productivity growth in manufacturing (though as I show here, not so much of late; see also Sue Houseman’s important work on this point). But this endless drumbeat about manufacturing jobs falling prey to automation seems at least woefully incomplete, if not non-economic.

First, trade and automation interact and are thus not clearly separable forces. Technological advances in communication and transportation interact with globalization to facilitate offshoring and deeper global supply chains. Nor should anyone convince themselves that it matters to workers which force is displacing them. Gutierrez implicitly argues that because it’s automation, not trade, displaced workers should somehow be assuaged. Hey, all they need to do is go from running a drill press to designing, building and programming drill-press-running robots!

Second, if productivity killed jobs, full stop, unemployment would typically be through the roof. The intervening variable has always been demand, as productivity growth generates rising real incomes that supports stronger demand and higher living standards, at least on average (if not “on median”).

We thus must ask ourselves what happened to diminish the demand for American manufactured goods such that employment in the sector fell, both in absolute terms since 2000, and as a share of total employment for decades, as shown in the figure. The answer is, of course, import substitution. American consumers have increasingly met their demand for manufactured goods through imports.

That has its pluses, as Gutierrez points out, but also its minuses: it has certainly hurt vulnerable manufacturing communities, in no small part because policymakers refused to help them adapt to the change. Moreover, this import substitution was much exacerbated, especially in the GW Bush years, by persistently large trade deficits in manufactured goods.

What does any of this hafta do with NAFTA? It’s just way too simple to brush people’s discontents about trade deals like NAFTA to automation or their failure to side with elites on how benign globalization has been (Hey, it’s reduced prices! Cheap stuff, everybody! Stop complaining!).

On what to do next, read Lori Wallach and I here for ways to make trade work better for workers, and read Dean Baker here for a highly efficient read on the costs of ignoring the downsides of globalization (of which the steepest is President Trump).

*A friend suggests a good point. Both of these shares–output and employment–fall in all advanced economies–see Germany, e.g., which at least recently runs large trade surpluses–as economies get richer and services overtake manufacturing. My point is that the decline in manufacturing output share has not been stable while employment tanked, which would imply faster productivity gains (or automation) than actually occurred.