The pace of productivity growth and misallocation in the United States

Posted on by Nick Bunker

Productivity is a term bandied about by academics, policymakers, and pundits alike, yet most of us aren’t sure what it means—even though we know it when we see it. In common day usage, the term evokes images of workers diligently typing away at desks or laboring hard on the factory floor, as well as annual performance evaluations by the boss. These everyday views of productivity are accurate yet at best ephemeral and at worse confusing—especially when trying to sort out how productivity relates to overall economic growth in the United States.

But for economists focused on economic growth, productivity is the Holy Grail. It’s the source of long-run economic growth and steady wage gains for workers. And that’s why, in the wake of the Great Recession, there are fears that productivity’s best days are behind us. Has productivity growth declined? And if so, what’s the reason? Answering these questions requires a clear understanding of what we mean when we talk about productivity.

First, there is what economists call total factor productivity. This measurement of productivity originated in spirit, if not name, from the research of Nobel Laureate Robert Solow on long-run economic growth. Solow, now Professor Emeritus at the Massachusetts Institute of Technology (and a member of our steering committee), was trying to figure out how much increased savings in an economy could increase the pace of long-run economic growth. He found that savings don’t do much at all.

Solow parceled out the sources of growth to increases in the labor force (population growth), increases in capital (savings), and a residual term that captured all the unexplained part of growth. His calculations showed that this residual was the main driver of long-run economic growth. Faster population growth or higher savings might boost growth in the short term, but then per-capita growth would return its old rate. Only increases in Solow’s residual seem to increase the pace of long-run economic growth.

This residual is often called “technology,” but it’s also known as total factor productivity. The concept started out explaining output growth for countries, but it can be used to describe the performance of smaller economies such as cities or even individual firms. Total factor productivity tries to figure out how well a country, city, or firm combines capital and labor to create output. Whether changes in this efficiency of output come from technology, management practices, culture, or some other factor is a matter that economists fiercely debate. To put this back in the context of the Solow model, understanding what increases TFP growth is the same as understanding what’ll boost output per capita growth.

But, if you try to look up U.S. government statistics on productivity, you’ll likely find data on labor productivity. Labor productivity is what it sounds like—a measure of how productive labor is. More specifically, it shows how much output is created for every hour of work done by a laborer. Take the amount of output produced, divide it by the number of worker hours it took to create the output, and the resulting number is your labor productivity. Importantly, though, labor productivity also is derived from total factor productivity. Take the growth in total factor productivity, add the increase in the capital workers can use from investments and account for changes in the kinds of workers in the labor force (including increases in educational levels and demographic changes), and you have the increase in labor productivity.

A debate about the source of long-run economic growth and wage growth would be important in any context. But it is especially relevant today given the slowdown in productivity growth over the past decade compared to growth levels seen before a burst in productivity growth in the late 1990s and early 2000s. Since 2003, labor productivity has slowed considerably from its pace during that period and compared to earlier periods in the postwar era. According to data compiled by John Fernald, an economist at the Federal Reserve Bank of San Francisco, trends in labor productivity look something like this:

  • 1948 to 1973—grew at an annual average of 3.3 percent
  • 1973 to 1995—growth declined to an annual average of 1.48 percent
  • 1995 to 2003—growth bounced back to an annual average of 3.38 percent
  • 2003 to 2007—growth slowed again to an annual average of 1.57 percent
  • 2007 to 2013—growth increased only slightly to an annual average of 1.83 percent

 

Why these wide swings in labor productivity? A look at total factor productivity growth provides some clues. Here are the trends in total factor productivity over the same periods:

  • 1948 to 1973—grew at an annual average of 2.15 percent
  • 1973 to 1995—growth declined to annual average rate of 0.47 percent
  • 1995 to 2003—growth improved to an annual average of 1.81 percent
  • 2003 to 2007—growth declined to an annual average of 0.71 percent
  • 2007 to 2013—growth improved marginally to an annual average 0.75 percent

 

Other contributors to labor productivity mostly increased over these periods. Due in part to rising education levels, growth in what Fernald calls “labor quality”  went from 0.27 percent in 1948-1973 to 0.43 percent in 1973-1995.  Labor quality growth ticked down just a bit during the 1995 to 2003 period to 0.40 percent and fell quite a bit more, to 0.24 percent, during the 2003 to 2007 period. It has since jumped up to 0.59 percent in the 2007 to 2013 period.

Similarly, more capital was a contributor to the increase in labor productivity growth, with the growth rate of capital deepening rising from 0.57 percent in the 1973 to 1995 period to 1.17 percent annually from 1995 to 2003. It’s fallen since then, averaging 0.61 percent during the 2003 to 2007 period and falling again to 0.49 percent during 2007 to 2013.  (See Figure 1.)

Figure 1

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As these data show, we really can’t blame the slowdown in labor productivity specifically on declines in capital accumulation, investment rates, or a deterioration in labor quality. According to Fernald’s decomposition, something else happened that caused a decline in the underlying pace of total factor productivity. What exactly could be the cause of this decline?

A recent working paper by Stanford University economist Charles Jones is helpful for thinking about this conundrum. Jones splits up total factor productivity into two factors. The first is the contribution of technology or knowledge to the pace of economic growth. Call it the stock of human knowledge. The second factor is far more nebulous. Jones calls it “M.” He’s very upfront about the fact that “M” could very well could stand for “measure of our ignorance” about the sources of growth. Jones does venture that given new research on productivity, that “M” might also be called “misallocation.”

Misallocation stories about productivity are less about the need to spur new innovations and more about understanding that many firms and individuals are already quite productive or have the ability to be more productivity if put in the right situation Jones highlights one paper that shows how women and people of color’s entrance into higher-skill occupations provided a significant boost to economic growth. That’s a matter of the misallocation of society’s workforce. The same phenomenon is evident in another study that shows the potential gains from allowing more workers to live in high-productivity cities.

There’s a similar story when it comes to firms. Research from the Organisation for Economic Co-operation and Development shows that there are firms operating among its 34 developed and rapidly development member nations that have quite high total factor productivity growth. The problem is that the insights and innovations from those firms haven’t spread to the rest of the firms.

What’s broken that transmission mechanism from these vanguard firms to the rest of the population? The decline in the rate of new business formation could be a likely candidate. If fewer innovative start-up firms are being created, then it makes sense that it would take longer for new ideas about how to run companies to diffuse throughout these economies. In the United States, the rate at which new firms enter the economy has been on the decline since the late 1970s.

But what explains the slowdown in the start-up rate? That isn’t clear, but some research by economists Ian Hathaway of Ennsyte Economics and Robert E. Litan at The Brookings Institution indicates that the slowdown in population growth and an increase in business consolidation could be the culprits. One of the reasons the number of public companies is on the decline in the United States is because of increasing mergers and acquisitions activity.

Since the late 1970s, overall productivity gains haven’t translated into broadly shared gains for the entire workforce as compensation inequality has increased. And since 2000, the gains from productivity across the U.S. economy are accumulating more and more toward the owners of capital instead of compensation for workers, as the labor share of income has been on the decline. Possible links between less equitable economic growth and declining productivity growth need to be explored because the pace of productivity growth sets the bound for how much standards of living can rise.

Must-Read: Lawrence Summers: Why the Fed Must Stand Still on Rates

Posted on by Brad DeLong

Must-Read: What is the technocratic economic–not the “the unemployment rate is normalizing so the interest rate should be normalized too” argument? For a person to be lying in a bed 24/7 is not normal. But if they have a broken leg you don’t make them normal by making them get up and walk around.

Lawrence Summers: Why the Fed Must Stand Still on Rates: “The case against a rate increase has become somewhat more compelling even…

…than it looked two weeks ago…. First, markets have already done the work of tightening…. Second, the data flow suggests a slowing in the U.S. and global economies and reduced inflationary pressures…. Third, the case for concern about inflation breaking out is very weak. Market based expectations suggest that inflation over the next decade on the Fed’s preferred core pce basis is near record lows and well below 2 percent. The observation that 5 year inflation, 5 years from now is expected to be below target calls into question arguments that current low inflation is somehow transitory….

Fourth, arguments of the “one and done” variety or arguments that the Fed can safely raise rates by 25 BP as long as it’s clear that there is no commitment to a series of hikes are specious. If as some suggest a 25 BP increase won’t affect the economy much at all, what is the case for an increase? And when the same people argue that 25 BP will have little impact and that it is vital to get off the zero rate floor, my head spins a bit. In a highly uncertain world, the Fed cannot be both data dependent and predictable…. I understand the argument that zero rates are a sign of pathology…. The problem is that the case for hitting the brakes in an economy with sub-target inflation, employment and output is not there; regardless of whether the brakes are to going to be pressed hard or softly, singly or multiple times…. Policymakers who elevate credibility over responding to clear realities make grave errors….

Fifth, I believe that conventional wisdom substantially underestimates the risks…. Not a single post war recession was a predicted a year in advance…. If history teaches anything it is that financial interconnections are pervasive and not apparent till it’s too late…. Now is the time for the Fed to do what is often hardest for policymakers. Stand still.

Must-Read: Nate Silver: Stop Comparing Donald Trump And Bernie Sanders

Posted on by Brad DeLong

Must-Read: Nate Silver calls out David Brooks and George Packer and Jonah Goldberg. May I say that the New York Times made a major mistake when it decided to let Nate Silver but not David Brooks go? And that the New Yorker would be well-advised to give Nate Silver George Packer’s inches?

Nate Silver: Stop Comparing Donald Trump And Bernie Sanders: “A lot [David Brooks] of people [Jonah Goldberg] are linking [George Packer] the candidacies of Bernie Sanders and Donald Trump…

…under headings like “populist” and “anti-establishment.” Most of these comparisons are too cute for their own good…. You can call both “outsiders.” But if you’re a Democrat, Sanders is your eccentric uncle…. Trump is as familial as the vacuum salesman knocking on your door…. Sanders is campaigning on substantive policy positions, and Trump is largely campaigning on the force of his personality…. Sanders is a career politician; Trump isn’t. Let’s not neglect this obvious one. Bernie Sanders has been in Congress since 1991, making him one of the most senior members of Congress; Trump has never officially run a political campaign before…. Sanders holds policy positions of a typical liberal Democrat; Trump’s are all over the place…. Sanders’s support divides fairly clearly along ideological and demographic lines; Trump’s doesn’t…. fight. Clinton’s position relative to Sanders is analogous to the one Al Gore held against Bill Bradley in the 2000 Democratic primary. Sanders’s campaign also has parallels to liberal stalwarts from Howard Dean to Eugene McCarthy; these candidates can have an impact on the race, but they usually don’t win the nomination…. Trump is engaged in an attempted “hostile takeover” of the Republican Party…

Noted for the Afternoon of September 9, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Must-Read: Jason Furman: It Could Have Happened Here: The Policy Response That Helped Prevent a Second Great Depression

Posted on by Brad DeLong

Must-Read: I used to think that Jason had this right. I am now worried he doesn’t. Barry Eichengreen keeps arguing that the memory of the lessons of the Great Depression was strong enough to halt the crash, but not strong enough to get policies adopted to spur the recovery. Thus, Barry argues, it may well be that–somewhat paradoxically–the fact that a second Great Depression was avoided in the short run may well mean that the longer-run consequence will be that 2007-9 will cast a larger and darker economic shadow on the future of the global economy than was the economic shadow cast by 1929-33.

Jason Furman: It Could Have Happened Here: The Policy Response That Helped Prevent a Second Great Depression: “The achievement of avoiding a second depression is not one to be minimized…

…The similarities between macroeconomic variables during the onset was in many respects worse than in 1929 and 1930, but the policy response and the resulting outcomes could not have been more different. As difficult as it was losing hundreds of thousands of jobs per month, the 20 percent-plus unemployment rates of the 1930s should not be forgotten. As United States–and global–economic policy shifts its focus from crisis response to continued structural reform, it will be important to learn from what has worked and what has not as we continue to encourage more, shared growth in the twenty-first century.

The Dispute Over the Trend Compensation Share of Labor: Is the Decline Secular or Cyclical, Workplace Power or Technology-Driven?

Posted on by Brad DeLong

I score this for Larry Mishel…

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Larry Mishel: Inequality is Central to the Productivity-Pay Gap: “The point is to show that the pay of a typical worker…

…has not grown along with productivity in recent decades, even though it did just that in the early post-war period… a substantial disconnect between workers’ pay and overall productivity… that has not always existed…. [Matthew] Yglesias argues that the major reason for the divergence is the different methods that must be used to adjust each line for inflation. This is flat wrong…. I quantified the factors behind the divergence of median hourly compensation and productivity for the period between 1973 and 2011…. The three wedges that are responsible for the productivity-pay gap are:

  1. Changes in labor’s share: an overall shift in how much income in the economy is received as compensation by workers and how much is received by owners of capital;
  2. Compensation inequality: growing gaps in wages, benefits, and compensations between the top 1 percent, and high–, middle-, and low–wage workers;
  3. “Terms of trade”: the faster growth of the prices of what workers buy relative to the prices of what they produce.

The first two items are dimensions of rising inequality, while the third item is the one highlighted by Yglesias as the “big problem”:

Inequality is Central to the Productivity Pay Gap Economic Policy Institute

Matthew Yglesias: Hillary Clinton’s Favorite Chart Is Pretty Misleading: “Workers’ pay hasn’t kept up with the growing productivity of the American economy…

…Hillary Clinton has offered up her own version… as part of her campaign’s larger theme that a Clinton administration will bring much-needed higher pay. But while the image is striking and depicts something real and important about the economy, it’s also fairly misleading…. One problem… is that economic productivity simply has nothing to do with ‘working hard.’ A guy who moves furniture for a living works very hard, but he does not generate much economic value per hour…. Highly productive workers are generally productive due to some combination of rare and valuable skills and access to useful technology….

But the bigger problem is that both lines are indexed to inflation–using different inflation indexes. The result is a chart that seems to suggest that further increases in productivity would be useless or unnecessary as a path to higher wages and incomes, when the real truth is the reverse….

The Consumer Price Index… tries to measure the price of what a typical [urban] consumer… buys…. The Implicit Price Deflator… tries to measure the price of everything that is produced…. These are different ideas. American consumers buy airplane tickets, but they generally don’t buy airplanes. Consequently, the price of a Boeing 777 isn’t part of the CPI basket…. When you draw a chart that uses both of these inflation indexes… the divergence between the two ways of looking at inflation is naturally going to drive divergence….

There’s no right way to do it. You can’t feed your kids a commercial jetliner or exports of business software, so saying something like, ‘Real wages have actually gone up a lot as long as you count a bunch of stuff that nobody buys in the price index’ doesn’t make much sense. On the other hand, making business equipment and software is a very legitimate line of work. Saying, ‘The economy really hasn’t grown much if you don’t count America’s most vibrant and innovative industries’ is pretty blinkered. Probably the best way to get an apples-to-apples comparison is to not adjust for inflation at all… nominal GDP versus nominal compensation… look at the ratio:

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It shows that… the gap is pretty clearly a direct consequence of… the Great Recession…. The best cure is not a huge structural overhaul… [but] for Janet Yellen and her colleagues at the Federal Reserve to be extremely cautious about raising interest rates. High unemployment makes it easy for employers to skimp on paying their workers, while stretches of full employment push the ratio up. To get back to pre-2000s level, we’ll need more years of recovery…. The popularity of the inflation-mixing chart among liberals is unfortunate, and has prompted public confusion. But the idea of some conservative wonks like James Sherk of the Heritage Foundation to note the issue, debunk the chart, and then move on is also misguided….

Real wages really have risen much too slowly over the past 40 years. But while Clinton’s version of the chart makes it look like rising productivity isn’t part of the solution, looking at the divergent price indexes clarifies that it is crucial. For real wages to rise, we need the things middle-class families spend the bulk of their income on to get cheaper. That means more productivity in the big housing, health, and education sectors–not more pessimism about the potential of productivity.

The open questions Matt raises are: which of these two graphs below would we get if we got a low-unemployment high-pressure economy over the next five years? What is the real trend here?

Matt thinks it is:

Hillary Clinton s favorite chart is pretty misleading Vox

Larry thinks it is:

Hillary Clinton s favorite chart is pretty misleading Vox

I am, once again, with Larry here. We have deep problems that are the result of the failure to spur a strong recovery. But behind those we have even deeper problems.

Caring for the elderly in America now includes a minimum wage and overtime

Posted on by Bridget Ansel

The U.S. Court of Appeals for the D.C. Circuit late last month reinstated a U.S. Department of Labor regulation that gives minimum wage and overtime protection to home care workers. The ruling upholds the Obama Administration’s decision to scrap the “caregiver exemption” from the Fair Labor Standards Act. The exemption excluded many of those in the home care profession from the most basic labor protections enjoyed by most other workers in the United States.

The ruling will affect almost two million home care workers who help the elderly and disabled manage chronic illnesses and do the tasks that allow them to stay in their homes. While the home care industry is the second fastest growing source of employment in the country—with an expected 1.3 million new jobs by 2020 ­– the workers are some of the most poorly compensated in the nation, with a median wage of $20,820 per year. Even in the midst of an improving economy and rising wages, home care workers have only seen their wages decline since 2009.

What’s more, those working in the home care sector over the past 80 years have done without the most basic protections under the Fair Labor Standard Act. When the FLSA was passed in 1938, it established a minimum wage, overtime pay, and child labor standards for full-time and part-time workers in the private sector. But the law originally excluded domestic and farm workers—occupations dominated by African Americans—as a concession to Southern lawmakers who thought that labor protections should only extend to white employees. By 1974, however, the law was amended to grant domestic workers, such as cooks, waiters, nurses, housekeepers, and gardeners, the right to overtime pay and a minimum wage. All domestic workers, that is, except for “casual babysitters” and a new category of workers defined as “elder companions.”

The exemption is just one example of how care work is devalued relative to other employment sectors. In 1974, nonemployed women were largely responsible for the round-the-clock care of family members, rendering its value invisible in the larger economy. Thus, lawmakers at the time (and the country as a whole) did not think to define care work as “real” in any economic sense. Yet as more and more women entered the labor market in force and could no longer take on full-time caregiving duties for their elderly parents or relatives, these paid “companions” became necessary to the wellbeing of the elderly who did not want to or could not enter into a nursing facility.

The home care industry argues that these new requirements will compromise their ability to provide affordable home healthcare for the elderly. This is a legitimate concern. While some of these companies enjoy hefty profits, many others rely heavily on joint federal-state Medicaid reimbursements (the way in which Medicaid funding is structured for home care is varied depending on the state). These more Medicaid-dependent companies may want to pay their workers more, but cannot without a subsequent increase in Medicaid funding. The court’s ruling could well compromise the ability of some home care companies to provide affordable services or employ workers full-time.

Despite these apprehensions, the court ruled against the industry. The decision was partially based on the fact that 21 states have already enacted minimum wage statutes for home care workers, and another 15 states mandate both minimum wage and overtime protections that are within the scope of the U.S. Department of Labor’s new rule. The court’s opinion also cited a lack of reliable data that home care workers in these states were adversely affected, pointing to evidence that the quality of care for the elderly at home did not decline. More information will be needed to evaluate the effects of the court ruling, but there does not seem to be a huge difference in states that mandate overtime for home care workers and those that do not.

This ruling has important economic consequences. Care work underlies what economists call “human infrastructure,” and has effects far beyond any single individual or company. Without these care workers, more people would have to give up jobs and take on considerable financial hardship in order to stay home with an ailing parent. This not only deprives many families of much needed earnings and future retirement savings, but also shrinks the labor supply and hurts the economy’s ability reach its full potential.

The court’s decision has great symbolic importance as well. The care work that is paid and accounted for in U.S. labor market statistics is clearly still undervalued both financially and culturally. But, with the new ruling, home care workers not only gain basic labor market protections, but also gain long-overdue recognition that their work is productive and essential for the U.S. families and the wider economy.

Must-Read: Tim Duy: Flying Mostly Blind Heading Into the September FOMC Meeting

Posted on by Brad DeLong
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Must-Read: The extremely sharp and IMHO under appreciated Tim Duy has a very nice way of putting the Federal Reserve’s current problem: which set of labor market indicators does it believe?

Of course, since we do not know which to believe, that in itself is an argument for not tightening in order to explore the policy space…

Tim Duy: Flying Mostly Blind Heading Into the September FOMC Meeting: “Through the eyes of Federal Reserve Chair Janet Yellen as she scoped out the economic landscape in 2013…

…With unemployment at the Fed’s estimate of the natural rate, inflationary pressures will soon emerge. To be sure, wage growth remains flat, but even Yellen leans toward writing that off as an expected outcome of low productivity growth…. When combined with stable inflation expectations, policymakers have good reason to be confident that actual inflation will soon reverse course and trend toward the Fed’s target. In such an environment, financial accommodation needs to be withdrawn pre-emptively to avoid overshooting the targets…

But:

Labor markets remain far from healed if viewed through the eyes of Yellen in 2014: Low wage growth is thus consistent with the hypothesis that underemployment indicators are important measures of labor market health. The persistence of weak wage growth should leads to revised estimates of the natural rate of unemployment. After all, targeting 5 percent unemployment when the natural rate is 4 percent means denying jobs to roughly 1.5 million people. That’s no small responsibility…. If you are uncertain of your estimate of the natural rate and inflation is moving away from target, why rush to hike rates?… And market-based measures of inflation expectations do not signal a revival of inflation anytime soon. Recent financial turbulence also calls into doubt the wisdom of raising rates next week….

Ultimately, the Fed will need to choose between one of these two arguments, and by doing so they will define a direction for policy. This will be important new information. Ultimately, we will learn who rules the roost at the FOMC–the Janet Yellen of 2013, or the Janet Yellen of 2014.”

Must-Read: Charlie Stross: The Present in Deep History

Posted on by Brad DeLong

Must-Read: What will people in 3000 remember from the history 1700-2300? I would say:

  1. Universal literacy.
  2. Artificial birth control.
  3. The coming of the Replicator–or close enough–for foodstuffs and for things made out of metal, wood, plastic, and sound.
  4. The coming of information technology in whatever its flowering will be.
  5. The death of global distance.
  6. Plus whatever disasters lurk at the bottom of not the Pandoran but the Promethean Box of 1700-2300.

But I am an optimist…

Charlie Stross: The Present in Deep History: “Assume you are a historian in the 30th century…

…compiling a pop history text about the period 1700-2300AD… a 600 year span—around the duration of the entire mediaeval period. Events a mere 20 years apart, such as the first and second world wars, merge…. Individual people… are a jumbled mass of names with dates attached. [What are] the big issues… big enough to remember half a millennium hence, like the Black Death, the Crusades, or the conquest of the Americas[?]… Anthropogenic climate change is obviously one of the big ones, and I have a number of others in mind; I want to see if I’ve missed anything obvious…. My list of candidates are:

  1. The great fossil fuel binge
  2. The population/GDP/innovation bubble (fueled by #1)
  3. The parasite crash and social rebalancing, including the end of patriarchy (made possible by medical advances facilitated by #2)
  4. The end of [vertebrate] meat eating (side-effect of #1 and #2)
  5. The collapse of cognitive distance and the perfection of memory (side-effect of #2)

Noted for Lunchtime on September 8, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Might Like to Be Aware of: