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Productivity growth is clearly slowing, and the key question is, is this a purely cyclical development or is it signaling a slowing in the long term trend growth rate.

Slowing productivity is a normal cyclical development and it is such a strong pattern, that historically, it has been a very good leading indicator. But this implies that we can not really determine if the recent slowing is just cyclical weakness or a trend shift.

To answer this question we need to look at indicators that either lead or determine productivity growth. It is a question economists have been researching for years

But clearly a major factor in productivity growth is the real capital stock per worker and it is generally widely accepted that this accounts for a quarter to half of productivity growth. Moreover, it also leads productivity growth by about a year.

There is also a long term relationship between trend productivity growth and trend growth in the real capital stock per workers as the following chart demonstrates.

From WW II until the late 1970s, early 1980s there was a very strong and relatively stable trend growth rate for both productivity and real capital stock per employee. But in the 1980s economic cycle growth in the real capital stock per employee stagnated, as it was still the same in 1990 as it had been in 1982. There was a cyclical bump in the early 1990s but this was driven more by a drop in employment then by stronger investment. With the capital spending boom of the late 1990s growth in productivity and the capital stock per employee surged again. But in recent years growth has stagnated again as since the Bush tax cut it has failed to grow.

This data on growth in the real capital stock per employee strongly implies that the recent slowing in productivity growth is not just a cyclical slowdown. Rather it looks like a shift to a slower growth trend driven by weak capital spending.

Obviously, given the limitations of blogging I can not get into much of a discussion of why growth in the real capital stock per employee did not grow in the 1980s or in recent years. However, these results are exactly the opposite of what the advocates of supply-side economics or republican trickle-down policies have promised. Maybe the simple answer is that there is no significant relationship between tax policy and capital spending.

But on the other hand since WW II the US has experienced good growth in the capital stock per employee except in the years when supply side economic policies were in place. I’ll leave it to the advocates of such policy to explain these discrepancies. However, I believe this is the fundamental or core reason why Cactus keeps finding that the economy does better under democrats than under republicans

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Government VS private waste

In looking at the question of whether business or government is more wasteful it might actually be possible to use the pro-business argument to demonstrate that business is actually more wasteful.

The argument is that government does not have competition to force it to quit doing something so it continues to do things when they are no longer needed. I agree it is a valid argument.

The argument continues that competition forces inefficient firms to close down and they commonly cite examples of bad firms like Enron or Countrywide to document their case.

But they make their case with a few examples and virtually never look at aggregate data.

There was a study in the BLS monthly Labor Review of May, 2005 that actually looked at this issue.

The looked at how new businesses survive. They found that 33% of new business fail in the first two years and 56% fail within four years. I’ve heard these types of numbers cited for restaurants, but this study found that there really was no significant difference between the failure rate for restaurants and other industries.

The study also looked at other studies of the survival rate or exit rate for established firms. The studies they cited found that for established firms about 50% go out of business every four years and over 60% exit every five years.

The numbers are not exactly comparable, but the BLS study found that roughly 20% of US firms close down every year. That has to be a tremendous misallocation of resources. Remember, these will generally be smaller firms. But it is like the data on job creation. You hear all the time that small firms create most jobs This is true, but they also destroy more jobs so that over time their share of employment never seems to grow.

So what we are looking at is that government is wasteful because competition does not force it to quit doing some things. But on the other hand having some 20% of US businesses closing down every year also seems to be very wasteful. I’m deliberately using the term wasteful, not efficient because efficiency and wastefulness are not exactly the same thing.

On balance I do not how to make a meaningful comparison of these two phenomena. One reason is that I have no estimate of how much of government should be closed down.

So I have no idea whether the private sector or government is more wasteful. But I doubt that very many of the individuals making the case for private business not being wasteful are really aware how wasteful private business really is even though hand having 20% of US businesses closing down every year may be highly efficient because it is the best we can do.

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