Looking for the roots of total factor productivity growth

Posted on by Bridget Ansel

To paraphrase the legendary football coach Vince Lombardi, productivity isn’t everything when it comes to economic growth; it’s the only thing. That might be a bit of hyperbole, but economists today agree that the efficiency of the production of goods and services given levels of capital and labor in an economy—its total factor productivity— is the key determinant of the pace of economic growth. Unfortunately, they have yet to figure out exactly what drives growth in total factor productivity, a critical task if we want to boost growth in the long run.

Let’s first take a quick look at the roots of total factor productivity. In two papers published in 1956 and 1957, Robert Solow, now an emeritus professor of economics at the Massachusetts Institute of Technology, showed that the source of long-run economic growth per capita wasn’t increased savings or faster population growth but rather a residual that he labeled “technology”. Calling something a “residual” usually doesn’t make your audience think that it’s the most important thing in the world, but Solow eventually won the Nobel Prize for this work—and the vast majority of economists today agree that this technological residual, now commonly known as total factor productivity, is the key source of long-run growth.

Economists who study economic growth have long been trying to understand the source for differences in total factor productivity. In a recently published working paper, Stanford University economist Charles Jones details a number of facts about economic growth including the role of total factor productivity growth. Jones cites one calculation that 80 percent of the growth in economic output per person since 1948 is due to such growth. And the difference in output per person across countries is very strongly related to differences in total factor productivity.

Jones breaks down total factor productivity into two factors. The first is the stock of knowledge in an economy, which is probably what most people think of when they hear the word technology. A larger stock of knowledge helps economic growth as individuals know how to best use labor and capital to boost economic growth. The second factor is what Jones calls “M.” One possible interpretation of “M,” he says, is that it stands for “misallocation.” Higher total factor productivity growth could be the result of less misallocation in the economy. Jones cites a study that look at how less discrimination against women and black workers in higher-level jobs increased economic growth in the United States as just one example of his M factor,

But “M” might also stand for the “measure of our ignorance,” as Jones points out. Indeed, the possible sources of total factor productivity growth are myriad: misallocation, better government and labor market institutions, “culture,” and a variety of others. In short, M could well stand for Mysterious.

If the concept of M were not daunting enough, economists are also looking at how they measure and conceive of productivity itself. Dietz Vollrath, an economics professor at the University of Houston, points out that the current categorization system for economic firms is tilted toward better understanding of manufacturing firms. The system was created when manufacturing was a larger portion of high-income countries. The result of this better data has been that most studies looking at productivity look at manufacturing firms. In today’s economy that misses out on the majority of economic activity in the services sector

Ryan Decker, a graduate student at the University of Maryland, agrees and adds that data aren’t the only problem. The concept of total factor productivity, at least at the firm level, was conceived for understanding manufacturing firms. It might be difficult to graft that concept onto service-sector firms. As Decker puts it, “The further you get from producing widgets with machines, the harder it is to map the TFP concept to the real world.”

The possibility that the most studied and discussed productivity concept might be flawed is discouraging at best, but perhaps the flaws Vollrath and Decker identify aren’t that large, which would be encouraging. But then economists would still have the task of understanding what actually drives the growth of total factor productivity. Let’s hope that task doesn’t take the economics profession as many centuries as it did before Solow detailed his “residual.”

Things to Note on the Afternoon of May 12, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Must-Read: Medicins sans Frontieres: The Trans-Pacific Partnership: A Threat To Global Health?

Posted on by Brad DeLong

Must-Read: Medicins san Frontiers: The Trans-Pacific Partnership: A Threat To Global Health?: “We have concerns with several U.S. government demands in the TPP…

…The TPP would lower the standard for patentability of medicines… force TPP governments to grant pharmaceutical companies additional patents for changes… [that] provide no therapeutic benefit… [thus] facilitat[ing] ‘evergreening’ and other forms of abuse of the patent system…. ‘Data exclusivity’… blocks competing firms from using previously generated clinical trial data to gain approval for generic versions of these drugs and vaccines. If pharmaceutical companies have their way, the TPP will block generic producers of biologics from entering the market for at least 12 years…. The Federal Trade Commission finds that no years of data exclusivity were necessary to promote innovation in biologic drugs. Twelve years of data exclusivity is not only unprecedented in any trade agreement, it is not the law in any of the TPP negotiating countries outside of the U.S…. The Obama Administration has actually called for data exclusivity to be reduced to seven years at home, so it is puzzling that the U.S. Trade Representative would be aggressively pushing for these terms in the TPP. These provisions and others currently included in the TPP are at direct odds with the U.S. government’s own long-standing commitments to global health…

Department of “Huh?!”: Noah Smith Claims the British Economy Today Is Not in a Keynesian Slump

Posted on by Brad DeLong

Real production in Great Britain is far below what we thought back in 2007 it would be today if British growth proceeded according to trend:

Graph Gross Domestic Product by Expenditure in Constant Prices Total Gross Domestic Product for the United Kingdom© FRED St Louis Fed

There are no signs looking at wages and prices that this is due to any adverse supply shock–that the reason production is so much lower than expected is not because aggregate demand has fallen short of potential output, but because something bad has happened to destroy the productive potential of the British economy:

Graph Consumer Price Index of All Items in the United Kingdom© FRED St Louis Fed

Thus there seem to be no reasons looking at wages, prices, and output to believe that the British economy right now is a full-employment at-capacity-utilization economy. And only in such an economy would monetary and fiscal policies that boost spending simply boost prices and not production.

Yet smart young whippersnapper Noah Smith says:

Noah Smith: U.K. Election Isn’t a Win for Austerity: “Whatever they are, the U.K.’s troubles don’t look very Keynesian…

…Austerity is unlikely to cure the British economy, but there’s not much reason to think fiscal stimulus would either…

Why does he say that fiscal stimulus is likely to be counterproductive? Because usually a depressed sub-potential economy has depressed employment as well, and the British economy does not:

Graph Employment Rate Aged 15 64 All Persons for the United Kingdom© FRED St Louis Fed

Does the fact that the employment share of British adults is actually high mean that the British economy is, in fact, at potential output? That stimulative monetary and fiscal policies risk rising inflation for no gain? And that it is time to normalize? Certainly Mark Carney at the Bank of England does not believe that is so:

Graph Interest Rates Government Securities Treasury Bills for United Kingdom© FRED St Louis Fed

And the Monetary Policy Committee says:

The pickup in output growth of the past two years had been largely met by a significant reduction in slack in the economy, particularly in the labour market, rather than by any increase in productivity. Although there was considerable uncertainty about the remaining extent of labour market slack, it was unlikely that activity growth could be maintained at its current pace for long, without generating greater inflation in wages and prices, in the absence of some material improvement in labour productivity…

The key phrase is: “considerable uncertainty about the remaining extent of labour market slack”. That means:

We do not understand how the labour-market indicators we monitor are consistent with both the output figures and the readings we have on wage and price inflation. The wage and price data suggests to us that there has been a sharp rise in desired labor-force participation since 2008 that has accompanied a collapse in labor productivity. But we find such a steep rise implausible. And we do not understand what might have produced it.

From my point of view, why so many Britons have taken so many low-pay low-productivity jobs in the past three years is a mystery. But that they have gives us little reason to think that the British economy is now a full-employment at-capacity-utilization economy in which aggregate demand is now equal to potential output.

Must-Read: Dan Walters: Finally, War on Prop. 13 Breaks Out

Posted on by Brad DeLong

Must-Read: The truly extraordinary thing about California’s Proposition 13 was not that it nearly froze residential real estate taxes as long as residents owned the property, but that it nearly froze commercial and industrial real estate taxes essentially forever. I do not understand how that provision made it into Jarvis-Gann in the first place–or how it has survived in California for so long…

Dan Walters: Finally, war on Prop. 13 breaks out: “A political war over taxes that’s been brewing for nearly four decades finally erupted Thursday–maybe…

…A union-led coalition of liberal groups launched a campaign to change Proposition 13, the iconic 1978 property tax limit, seeking billions more in revenue from commercial and industrial property owners. The coalition, Make It Fair, declared its intention to place a ‘split roll’ measure on the 2016 ballot, keeping Proposition 13’s limits in place for homes, residential rental properties and farms, but allowing upward revisions in taxable values on other properties. The ‘maybe’ qualifier is that… sponsors… indicated it would be dropped if many of the same groups decide to ask voters to extend Proposition 30, the temporary sales and income tax hike approved in 2012…

“Establishing” Health Exchanges: Ways Out of the King v. Burwell Trap

Posted on by Brad DeLong

The trouble that is the King v. Burwell case arises because of one sub-sub-section of the law which says “established by the state” rather than “established in the state” or “established for the state”. The purpose of “established by the state” in its context:

…the monthly premiums for such month for 1 or more qualified health plans offered in the individual market within a State which cover the taxpayer, the taxpayer’s spouse, or any dependent (as defined in section 152) of the taxpayer and which were enrolled in through an Exchange established by the State under 1311…

is not to keep subsidies from being paid to those who purchase insurance on the federal exchange but rather to restrict subsidies to health plans purchased by residents of California from the California exchange–rather than, say, from the Nevada exchange. But it says “by” rather than “in” or “for”. And misreading has its day. (Never mind that elsewhere in the law it says that if the state takes no action the federal government shall establish “such exchange”–where “such exchange” is that very exchange established by the state under 1311: you have to misread the “by” and not read the “such” at all to make the plaintiff argument.

Now comes Ann Marie Marciarille to focus on “establish”. As Nicholas Bagley writes:

Nick Bagley: King v. Burwell: “As the ACA uses it…

‘establish’ means ‘[t]o make or form; to bring about or into existence’…

And every single state has taken steps to bring its state exchange into existence and make it function, one example of which being where exchange coverage and state Medicaid coverage meet:

Ann Marie Marciarille: Missouri State of Mind: Pennsylvania Keeps the Door Open: “It is official, Pennsylvania has given notice…

…that it may choose to switch to a state operated exchange, should that be necessary to preserve subsidies after a potential ruling adverse to these subsidies through the federally facilitated exchanges under King v. Burwell. The letter leaves open whether or not this is something Pennsylvania will do as well as the terms of a potential jointly operated exchange. Of course, all exchanges (federal or state) are jointly operated in the functional sense, since the back-of-the-house operations have to merge state-specific Medicaid enrollment standards with nationalized-standardized federally-operated exchange applications and subsidies.

On one level, I just don’t get it. Every exchange, to a certain extent, is state operated and federally operated…. Post-Burwell… other states [could] announce and then implement hybrid exchanges.  But isn’t that what they already are functionally?

Must-Read: Ashok Rao: How Do Net International Positions Matter

Posted on by Brad DeLong

Must-Read: Where the smart young whippersnapper Ashok Rao shies at the jump here is in failing to specify where he thinks the market failure is, and how to correct it. Is the demand by foreigners for safe dollar-denominated assets an improper one? And why today is it only the U.S. government–rather than, say, Apple or Wal-Mart–that can tap this funding source? Or is there a deeper problem in that Apple and Wal-Mart could tap this funding source but really do not want to–that they already have all the capital and funding that they think they can use? These are the questions that people are worrying…

Ashok Rao: How Do Net International Positions Matter?: “Capital is supposed to flow from rich countries to poor countries…

…to finance development abroad, just like water should roll down a hill. Clearly that doesn’t square with the incredible amounts of cheap cash flowing into America, and the safe-asset squeeze (whether something that’s an actual market reality, or something that is an artifact of mercantilist/crisis-weary state policy) has a lot to do with it…. Foreign investors… are largely official, and have a single-minded interest in preventing the 1999 sort of debacle where a shortage of dollars resulted in… havoc…. American investors are almost exclusively private corporations that don’t have a shortage of dollar-assets, that almost never borrow in a foreign currency, and live in a world of really, really cheap basis trades. So private, social, and market valuations diverge…. The more simple description of the entire argument is that US treasuries provide a liquidity service to foreign governments and there is an inefficient shortage thereof. Or, even simpler, the US is a classical bank earning a profit on the spread between its borrowing and lending rates. Sometimes returns paint a more useful picture than valuations.

Must-Read: Jesse Cross-Call: Medicaid Expansion Is Producing Large Gains in Health Coverage and Saving States Money

Posted on by Brad DeLong

Must-Read: Jesse Cross-Call: Medicaid Expansion Is Producing Large Gains in Health Coverage and Saving States Money: “Among the states that have documented significant budget savings from the Medicaid expansion are:

Arkansas: Medicaid expansion… cumulative savings of nearly $120 million by the end of fiscal year 2015, includ[ing] $72.9 million in savings within the Arkansas Medicaid program from moving people who previously received care under specialized Medicaid categories… into the expansion’s new eligibility group, for which the federal government pays the full cost…. The state expects to collect $34.4 million in new revenue… from taxes… producing a total gain for the state budget of over $150 million in 18 months.

Kentucky: Medicaid expansion saved Kentucky $25.8 million in fiscal year 2014, and is expected to lead to another $83.1 million in savings in fiscal year 2015… $30… on behavioral health programs, $16.4 million from spending less on inpatient hospital costs for prisoners, and $16.4 million from moving people who previously received Medicaid coverage through a medically needy spend-down program into the expansion’s new eligibility group.

Michigan: Medicaid expansion saved the state $180 million in fiscal year 2014 and is projected to save Michigan $190 million in the state’s current fiscal year…. In addition, the state projects two-year savings of $19.2 million in its corrections system, as the federal government now covers the costs of prisoners hospitalized outside the corrections system, as a result of the Medicaid expansion.

New Jersey: As a result of the Medicaid expansion, Governor Chris Christie’s fiscal year 2016 budget proposal spends $148 million less on charity care and $417 million less on beneficiaries previously covered at the state’s regular matching rate…. The state expects the latter category to result in nearly $3 billion in savings to the state through 2020.

New Mexico: New Mexico will save $60 million from 2014 to 2016 by transitioning low-income adults who were receiving Medicaid coverage through a waiver prior to health reform into the expansion eligibility group… an additional $15.3 million in the current fiscal year because of lower demand for state-funded behavioral health…. The state also collected $30 million in new revenue in 2014 and expects to collect another $30 million this year from its premium taxes….

Washington: Medicaid expansion saved Washington $105.5 million in fiscal year 2014, and the state expects to save an additional $286.6 million in fiscal year 2015… $64.6 million in reduced behavioral health… $147.9 million from transferring adults awaiting a disability determination for Supplemental Security Income… to Medicaid… [plus] a $33.9 million increase in premium tax revenue in fiscal year 2015….

Must-Read: Joshua Brown: The Magnificent Five: Some Ridiculously Kind Words from Tren Griffin

Posted on by Brad DeLong

Must-Read: Joshua Brown: The Magnificent Five: Some Ridiculously Kind Words from Tren Griffin: “I’m literally blushing at some praise from Tren Griffin…

…What I like best about Ben Carlson is that he is young and very savvy about not only investing but the tools of social and other forms of modern media like Twitter and Tumblr. Too many of the people I write about who are able to teach others about investing are, well, either old or very old. People like Ben Carlson, Patrick O’Shaughnessy, Morgan Housel, James Osborne and Josh Brown (the Magnificent Five) represent the next generation in financial writing. They are fearless in confronting financial advice poseurs of all kinds. That they all are moving swiftly into media formats like video makes me hopeful they can successfully combat more of the hucksters pushing ‘easy wealth in seven steps’ style schemes. I am rooting for them, especially when they go after people like constantly self-promoting old coots flogging their financial flim-flams that hurt ordinary investors….

The coolest thing about this is that I know the other four guys personally and have hung out with them offline. They mean what they say and are the real deal. I’m totally flattered to be associated with this crew.