How can the stock market tank this much are not cause a recession?

January 22nd, 2016 at 11:16 am

Well, there’s the stock market and there’s the real economy. They’re related but they’re not the same thing. Here’s why. To be clear, nobody knows when the next recession will hit, so I’m decidedly not saying all clear, happy-dappy! To the contrary, I strongly urge us to be ready for the worst.

A quick look at recent wage growth

January 20th, 2016 at 5:52 pm

One can decompose the growth in real (inflation-adjusted) weekly earnings into the parts due to:

a) hourly wage growth
b) weekly hours worked
c) inflation

So, the growth in real weekly earnings = a + b – c, or nominal hourly wage growth plus hours growth minus the rate of inflation.

Now that we have inflation data for December, we can break apart real weekly earnings growth for 2015 into these components and compare it to recent years, in this case for blue-collar workers in manufacturing and non-managers in services. I’ve found this “production worker wage” to roughly track the pay of middle-wage workers. The black dot is the sum of the three building blocks.

Right off the bat, you see that after going nowhere for three years, real earnings gains rose in both 2014 and 2015, by 1.8% and 1.4%, respectively, for these middle-wage earners. Nothing to get exuberant about, but welcomed real gains for sure.

The other point is that it’s not so much faster hourly wage growth nor a lot more weekly hours driving the increases. It’s lower inflation. In response to the tightening job market, hourly wage growth picked up a bit last year, growing 2.4% in 2015 as opposed to the ~2% of the prior two years. But the big difference was the sharp decline in the CPI. Had prices risen at, say, 2%–a more normal pace–real weekly earnings would have been flat.

You can view that as a transfer of riches from Middle Eastern oil sheikhs to guys and gals on the production line, providing health care, teaching kids, and so on, which is fine by me. Or you can recognize that nominal wage growth is only now starting (maybe) to pick up its pace a bit, suggesting that (maybe) workers are gaining a little bargaining power as employers compete. And you can hope the Fed sees no reason to stop it.

 

Source: BLS

Source: BLS

 

The Productivity Slowdown: Mismeasurement or misallocation…or both?

January 15th, 2016 at 9:56 am

[This post is longer than usual. But then, understanding the productivity slowdown is more important than usual. Punchline: while some of the slowdown can be attributed to mismeasurement, meaning the slowdown isn’t as bad as it looks, I suspect part of it has to do with capital misallocated to unproductive sectors. Thanks to Dean Baker for comments on an earlier draft. Any mistakes are his my fault.]

Introduction: Great jobs results imply crappy productivity results

While I was just as happy as the next wonk to see the strong jobs report last week, it did trigger a nagging thought: productivity growth must be really slow.

I know, they don’t call it a dismal science for nothing. Who but an economist would find a sad undertone to a happy jobs report? But here’s a tiny bit of arithmetic to consider:

Productivity=Growth-Jobs

Now, we know that growth hasn’t been that strong of late, and we know that job growth has been pretty solid. Together, they imply slow productivity growth, and that’s the arithmetic I thought about on jobs day.

To make this more concrete, let’s plug these growth rates from the most recent productivity data (2015q3) into the formula:

0.6=2.5-1.9         (Those are year/year growth rates for the nonfarm business sector, where “jobs” is really hours worked.)

“Well,” you might be thinking, “I like jobs a lot more than ‘productivity,’ whatever that is. So I still don’t see the problem.”

Except these sorts of things aren’t really so separable. Productivity growth—the increase in the rate at which we produce an hour’s worth of output—is how we improve our living standards. The reason our nation is as wealthy as it is today is because of our productivity growth. (The reason that wealth has become so concentrated is that productivity growth is no longer flowing to the middle class the way it used to; that’s a different, albeit related, discussion.)

The figure below shows annual productivity growth since the 1940s, along with a smooth trend, which is the better way to look at this series (since it’s pretty jumpy). Since 2010, trend productivity growth has been running at around 1 percent. That’s pretty lame. From 1995-2005, it clocked in at a healthy 2.7 percent.

Source: BLS, (HP filter for trend)

Source: BLS, (HP filter for trend)

The question is, then, how do we regain our productivity mojo?

Don’t worry. It’s just mismeasurement.

One school of thought maintains that we haven’t really lost it (i.e., our productivity mojo). We’re just failing to accurately measure the value of lots of cool tech stuff, meaning we’re generating more output than the records show, and thus more output per hour.

I suspect there’s something to this, but it’s actually a very tricky point. First, you can’t just show mismeasurement. Since we’re talking growth rates, you have to show increasing mismeasurement. Second, you have to figure out how such mismeasurement gets counted and how much it’s worth. That’s as much art as science. Moreover, at least as I read the evidence, all of this speculation doesn’t alter the fundamental picture of a productivity slowdown.

One reason some analysts think we’re increasingly underestimating output is because computer prices in the national accounting system have, in recent years, stopped falling as quickly as they used to. Let me explain.

Suppose you bought a decent laptop in 1995 for $1,500. Now, supposed you go back to the store five years later and buy a new computer for the same price. Inflation should be zero, right?

Wrong! That new machine does a ton of stuff the old one couldn’t—it’s faster, lighter, has more storage, a better screen, etc. Let’s say it’s 20 percent better, meaning you got a 20 percent break on the price. In a truly quality-adjusted, no inflation world, it would have cost $1,800. But it costs $1,500. So, the price actually fell.

The figure below shows that such price declines were annual events back in the day. But in recent years, the computer deflator hasn’t fallen much at all. Have you noticed computers getting better at a slower rate? A number of economists have concluded the problem is we’re not recording the quality-adjusted price declines the way we should be. Thus, there’s more output and faster productivity growth. Relevantly, as you’ll see, some of that has to do with increased import penetration of computers and the fact that our price system appears not to be effectively capturing quality improvement in imported as opposed to domestically sourced IT equipment.

Source: BEA

Source: BEA

On the other hand, my intuition is that computers got a lot better—faster, with better web access—up until maybe a decade ago, and since then, their pace of improvement has slowed. It is possible that the trend above in IT prices is directionally correct.

But either way, how big a difference does this make? A Federal Reserve analysis of this issue points out that another symptom of this price mismeasurement is that we’re also probably importing more IT stuff, in real dollar terms, than the current accounts reflect. Remember, imports are a negative for growth. “Thus,” the Fed economists conclude, “the overall effect on observed GDP would likely be small, as the additional business investment would be largely offset by lower net exports. Similarly, the recent modest labor productivity gains would also not be revised up appreciably…”

Goldman Sachs economists dove into this question (no link available) and came to a different conclusion, arguing that a good chunk of the decline in productivity growth is a result of this pricing problem, along with missing all the benefits of free apps, websites, wifi, Google searches, and so on. For example, they report that Google’s chief economist estimates that the time saved by free searches may be worth $150 billion a year, or almost 1 percent of GDP (a bit like asking your barber to value your haircut, that).

Jeez, I dunno. They must be right about the direction. A lot of this stuff adds way more value then we pay for it (especially when it’s free!). But assigning magnitudes has got be largely hand wavy, and deciding that those magnitudes have grown—remember, they’ve got to prove not just mismeasurement, but increased mismeasurement—tends to invoke another layer of speculation.

It must also be the case that some technology makes life worse, i.e., that deteriorating quality adjustments would raise the prices of phone menus, robocalls, air travel. Are the national accounts accurately reflecting the efforts, costs, and downtime lost to fighting against computer viruses? Weirdly, economists virtually never consider that side of the equation. Some hand-waving is inevitable here but I worry about unidirectional hand-waving.

Economist Sue Houseman has also shown a way in which increased imports are leading to an upward bias in our productivity measures. Increased outsourcing of goods and labor lowers the cost, and thus increases the quantity, of intermediate goods in manufacturing, but again, due to anomalies in our accounting systems, we don’t pick up this cost decline. So we’re undercounting what goes into producing goods and thus overestimating output. Again, tricky, I know. But the point is there’s a tendency to just look around for stuff that biases output and productivity down, when some biases go the other way. As the dollar has gained considerable strength in recent months, imports are likely to accelerate, intensifying this bias.

All told, I believe the mismeasurement story but doubt it is of a large enough magnitude to change the fundamental productivity slowdown story. In a bit of my own hand waving, I suspect trend productivity growth is closer to 1.5 percent per year than to 1 percent. That’s still a problem.

Do worry. It’s misallocation of productive capital.

It’s hard to know what drives productivity trends up and down, but I’ve got a couple of theories. Investment in productive capital is a known driver of productivity growth, and its slower growth rate in recent years shows up as one reason for productivity’s deceleration. But that just begs the question: why the slowdown in investment? (My other theory is that there’s a full employment productivity multiplier—full employment drives firms facing higher labor costs to find efficiencies they otherwise didn’t need to maintain profits. I won’t get into that here but it suggests what I believe to be an important linkage between productivity growth and persistently weak labor demand.)

In fact, after accounting for measurement issues, our productivity problem may be less a slowdown than a misallocation. If you want to see what deeply damaging misallocation looks like, and be entertained by it (really!), go see The Big Short. Surely the (d)evolution of finance and its contribution to some pretty awful economic outcomes in recent years is diverting investment into non-productive sectors and activities. By devoting an increasingly significant share of GDP to non-productive finance, we become…um…less productive. Note that I am not suggesting that the level of investment is too low, though investment as a share of GDP is not quite yet back to pre-recession levels. This is an argument about its composition.

Some important new research ties this to another problem I tend to go on about: our large, persistent trade imbalances. These must be financed, and the capital flows can engender the “financial resource curse,” which links access to cheap foreign capital to slower productivity growth: “sustained current-account deficits driven by cheap access to foreign capital can produce a shift of productive resources toward non-tradable sectors such as construction [ahem…JB]. The resulting allocation of resources can hinder the development of a dynamic export sector and dampen long-run competitiveness, since the scope for productivity gains in the non-tradable sectors is relatively limited.”

This research emphasizes international capital flows, but especially in under-regulated financial markets, it’s not obvious to me that cheap capital needs to flow from abroad. Once inept (and wrongly incented) credit-rating agencies label dangerous junk as triple-A-grade securities, domestic investment—e.g., large pension funds—can slosh into unproductive sectors as well.

I find this research compelling. The conventional assumption is that flows that boost “I” (investment in the GDP equation) are always and everywhere pro-growth. This approach to analyzing the more nuanced impact and even the content of capital flows (investments in some assets are more benign than others) may help to develop a more realistic understanding of what’s driving productivity growth down in nations across the globe.

But wait. Didn’t the under-regulated-finance-inflated housing bubble implosion occur years ago? Yep. But such misallocation, I’m guessing (to be clear: a lot of this is new, unproven thinking), takes years to shake out, especially when it involves leverage, shadow banks, bailouts, and all the rest. “Extend and pretend”—where banks convince themselves that non-performing loans would soon come back to life—draws out the rebalancing cycle a lot more than “mark-to-market,” like when the value of your equities in pet rocks falls to zero from Monday to Wednesday.

Much more to be said here. This theory invokes the need for more careful oversight of the financial sector and capital flows. It once again reminds us that Panglossian assumptions of optimal capital allocation magically guided by the invisible hand are bunk. In this case, the invisible hand may be all thumbs.

It invokes the need for the public sector to invest what’s needed in productive public goods, as misallocation/financialization steers resources away such critical investments. I’ll write more soon on these implications. But for now, the key idea is to give the mismeasurement evidence its due, without overdoing it. More important, I think, is to focus on the negative productivity effects of misallocated capital and what can be done about it.