Relax DeLong & Krugman… productivity advances will appear when there is demand-space
Brad DeLong wrote a praised piece about growth… The Honest Broker: Is Growth Getting Harder? If so, Why, and What Can We Do About It?
Yes, it was an interesting piece, but I have a bit of a critique of one point concerning productivity. I see productivity as blocked by demand. But he doesn’t make that critical connection in his piece. First he quotes Brink Lindsley…
“Both Tyler Cowen and Robert Gordon argue that the productivity slowdown… reflects… exhaustion of the… great technological breakthroughs of the late 19th and early 20th centuries…” … “Was the IT revolution that has transformed our lives in so many ways really only good for a decade of strong productivity growth? Or is the current TFP slump merely a breathing spell in a long-term resurgence?”
DeLong does not quibble with the assumptions here. He accepts the explanation and then writes many passages about technology and innovation. Remember now… the issue here is the productivity slowdown and its effect on growth.
Let’s move along to another part of his piece…
“for the near-term, worries about “secular stagnation” are overwhelmingly either wrong or worries about how to solve the technocratic problem of mobilizing societal risk-bearing capacity and properly distributing our productive capacity among sectors and our output to individuals. We may fail to accomplish these tasks. But they are our most urgent ones. We should not let the intellectual interest of wondering about the long run shape of technological progress do too much to distract us from the urgent current public-policy problems of restoring full employment, reversing the pointless and destructive rise in inequality of income and wealth…”
He is saying that we should deal with distribution before we worry about technological progress. But not connecting the two…
“The point is this: things that make the production of things we buy more efficient – that make them cheaper – raise real GDP. And the larger is the expenditure share of a commodity in what we buy, the more does an improvement in the efficiency of its production boost real GDP per worker.”
Still no connection between productivity and demand.
“Thus I suspect that not innovation exhaustion but rather institution design will be our big problem in keeping the pace of true economic growth going into the long-run future.”
Here he links economic growth to institutional changes, not demand. Then he ends by giving the floor to Paul Krugman and his “Techno-optimism”…
“what Larry Summers and I have been suggesting is that we may face a persistent shortfall on the demand side. … But what do I think about Gordon’s notion that the good times of progress are behind us? One honest answer would be that I don’t know, and can’t even make a good guess.
“What I can say, however, is that my gut feeling remains that while Gordon may be right about the next decade or two, he’s likely to be very wrong beyond that. Or maybe it’s a bit more than my gut. I know it doesn’t show in the productivity numbers yet, but anyone who tracks technology has a strong sense that something big has been happening the past few years, that seemingly intractable problems — like speech recognition, adequate translation, self-driving cars, etc. — are suddenly becoming tractable.”
So in the end, we see their long-term faith in innovation as the answer to economic growth and the shortfall on the demand side. If we make better things better and cheaper, real GDP can grow.
Now my view… Demand is the obstacle standing in their way. Demand stops productivity growth and has many times over the decades. This graph shows how productivity stops when real GDP nears the effective demand limit.
Productivity will sit motionless against the effective demand limit for years. Then start to move as effective demand increases in an economic contraction. This next graph shows productivity growth in relation to changes in effective demand. (YoY growth at a moving average of 1.5 years, based on the quarterly data from the graph above.)
When effective demand (blue line) increases during an economic contraction, productivity (red line) increases too with a bit of a lag. The peak of annual productivity growth is fairly constant over the years, 2% to 4%. The times when productivity growth is low or zero, match with decreases in effective demand. It is interesting to note how productivity reaches its peak when effective demand is falling fast.
Apparently the current concern over productivity has DeLong, Krugman and others second guessing technology and future growth. But the block on productivity is simply declining demand. Productivity is held at 0% growth because of such weak effective demand.
Currently gains in productivity are matched by the disappearance of other production in a zero sum game. Thus increases in productivity balance to zero productivity growth against the effective demand limit. If one company increases productivity, other companies must lower their production. Profits between firms are crowded out at the effective demand limit. That is the economic constraint on productivity.
During an economic contraction (seen by effective demand going positive in the graph above), space is created for productivity to be released from the zero sum game. Firms can increase productivity and profits without the profits of other firms being crowded out. You will see, when the blue line above goes positive, expect a jump in productivity. Look how many times that has happened in the past.
DeLong and Krugman do not see this. Productivity growth is controlled by economic dynamics of demand and production.
They may not see this because labor share does not appear much in their writings. Effective demand is determined by the relationship of labor share to the utilization of labor and capital. Once you realize how far labor share fell since the crisis, then you realize how serious the constraint on productivity is. Without this realization, they are left searching for grand philosophical explanations, when the dynamic is actually simple.
So my words to DeLong and Krugman… Relax… the advances already made in productivity will appear as “demand-space” opens up during the next contraction… and the capacity for long-term economic growth is assisted by labor’s share of production.
Cited article…
DeLong, Brad. The Honest Broker: Is Growth Getting Harder? If so, Why, and What Can We Do About It? Washington Center for Equitable Growth. December 3, 2013.
Not to get too technical about this, but during economic downturns employers can demand almost anything of employees including working longer hours for the same pay–assuming they are salaried–because they are happy to still be employed and even if they are not they can be replaced from the large pool of qualified unemployed people. What happens is that a business lays off a third of its work force and still produces three quarters of its output–because the remaining work force is working so much harder–and the experts call it a boom in productivity. Of course effective demand falls because a third of the business’ employees are unemployed and three quarters of the output is plenty to meet that demand. If effective demand were to increase by for example government stimulus through deficit spending or taxing the wealthy more, the business would have to hire back the folks it laid off and initially productivity would appear to be falling or staying constant if the business can get back to 100% production with 10% less employees. That probably is not sustainable once the economy really gets going because the people who have been working more hours for the same pay will either demand more money or they will switch jobs.
Terry,
You bring up a humbling side of productivity. Workers are make to work harder during a contraction. But remember that productivity growth rarely goes negative. This means there is a base-line that holds steady. This means there really are productivity advances that get built into production.
My point is that those advances don’t show up until firms are able to expand production after a contraction in such a way that the productivity advances work their way into a larger share of production.
But you are right… some of the productivity growth is due to the labor effects in and after a contraction.
Shorter version: people don’t got money, they can’t buy stuff or services.
1 worker doing 3 jobs only buys 1 workers worth of stuff. 3 workers doing 3 jobs buys 3 sets of stuff.
What do you mean people ain’t got no money?
Come on guys! That’s why we have banks, no money down, greater than 100% financing and the derivatives market. 🙂
I did not mean to suggest that there are not productivity increases regardless of the place we are in business or larger cycles. Nor am I prepared to argue there is no relationship between effective demand and productivity growth–plainly one does not invest in a new, highly efficient manufacturing facility if the plant will be idle half the time because there is demand for only half of its output capacity. My point was simply that the number one impediment to growth is high unemployment/underemployment and that for once Obama got it right when he suggested that income inequality is the greatest challenge to our society, Kudlow’s suggestions to the contrary notwithstanding. Instead of growing the pie, the wealthy capitalists have taken an increasing share of the same size pie with the result that the pie is not growing anywhere near as much as it could.
I think this post is correct to point out the role of demand in driving productivity–but at the same time, it misses one of DeLong’s major points, which is, why obsess about growth in the first place? It is not a proper object of policy, so just let it happen. Anyhow, that is what I got out of DeLong’s piece (more here: http://www.economonitor.com/dolanecon/2014/05/27/why-the-correct-answer-to-what-should-we-do-about-slowing-growth-is-nothing/ )
Hello Ed Dolan,
It is unusual to see someone make a comment on a post so many months later. Yet, better late than never.
I read your post that you linked to. I truly wish economics was as advanced as you are. i agree with your steady state approach. I agree that growth should just be left to its natural rhythm. The main key is to have balanced institutions in place for social welfare.
When the Fed wants to keep nominal rates low for a long period, i do not like that. It is trying to force growth. Would you also agree with that view?
And for low wages, I realize there are reasons for lower wages, but some of the reasons are just unbalanced for society. Low wages will constrain productivity and social welfare. Low wages constrain natural growth for a balanced society with good social welfare.
My view is that we would see more growth with higher labor share, but we would also see more social welfare. So when I see the graph at your post, I see that the US could rise in social welfare and have better growth.
The key is to raise effective demand.
But you bring up a larger question… Do you even want more growth? Even though it could be healthy for society, is it healthy for the planet? I tend to say no… I think we have gone to far in consumption. Use of natural resources needs to reverse.
So then if growth slows down for the planet’s sake, will social welfare suffer? Not necessarily… we only need to establish balanced institutions for the economy to produce social welfare.
I now follow you on twitter so I can see when you have a new post.
Better late than never.
I would agree that the Fed should not force long-run growth. I can sympathize with its desire to try to speed the recovery and close the output gap with low interest rates, but not as a long-run policy. I think a more balanced approach that used more active fiscal policy to stimulate demand (rather than the procyclical austerity of the last couple of years) would close the gap more quickly and allow normalization of interest rates sooner.
You say, “So then if growth slows down for the planet’s sake, will social welfare suffer? Not necessarily… we only need to establish balanced institutions for the economy to produce social welfare.” I am glad to see we agree on that, which is really the main point.
Hi Ed,
Agreed… More fiscal policy would have been really great. I just don’t include the federal government in the equation of solutions anymore. The federal government is on a whole different page. They do not want social welfare. They want business welfare, and then say that it will bring social welfare. They are just not serving society anymore. People have to stand up for themselves.
And I really like what you added… “allow normalization of interest rates sooner.” Wouldn’t that have been nice?