Productivity is Demand Constrained
I was watching a video from the World Economic Forum 2013 in Davos, Switzerland. The video is a panel discussion on the subject, “No growth, easy money, the new normal”. The World Economic Forum 2013 took place in January 2013. It is basically a discussion of monetary policy in dealing with the crisis.
In the video (about 20 minute point), Ray Dalio who founded Bridgewater Associates says that future growth will have to be low-debt growth. The issue then becomes productivity and how countries become competitive. The next speaker, Brian Moynihan, CEO of Bank of America, then says that the labor force that an American business employs in the United States is not related to its business prospects due to the nature of globalization. Labor and sales are found globally. In effect, businesses can fulfill their demand and their general business plan globally.
After the 30 minute point, Brian Moynihan says the economic issue is really becoming a demand issue. There is plenty of liquidity within the financial sector, but the demand for production is not there. Ray Dalio then supports that idea by saying that the liquidity will somehow make its way into purchases… purchases of goods and services, equities, gold, you name it.
Ray Dalio (47 minute point) states 3 conditions for a good recovery that “debt doesn’t rise faster than income, that income doesn’t grow faster than productivity and productivity grows at a decent pace”.
Their argument is based on productivity increasing. But productivity is a complicated issue. Even in the United states, productivity has flat-lined for the past 3 years. Let’s look at some of the headwinds using 2 equations for productivity.
Productivity = National income / Total labor hours
We can see that if national income increases, then productivity will increase. But in order for productivity to rise faster than national income, total labor hours must increase but increase slower than national income. Thus economic growth will be productivity-led and not debt-led. This is what Ray Dalio describes.
There is a careful balance here between making the economy more productive with machines and computers, and also employing more labor. The tricky part is that machines and computers are requiring less labor. So certain companies may be more productive with machines, but if this becomes an overall trend, it may be very hard to increase total labor hours enough that growth will not be debt-led.
The second equation for productivity…
Productivity = Real hourly compensation / Labor share
There is a problem here. In order for productivity to increase, real hourly compensation must rise relative to labor share. They can both fall, it is just that real hourly compensation must then fall slower.
Can we even imagine wages and such falling more?… Yes.
At the 3:40 minute point, the panel member from France says that France is going forward with a plan to reduce labor costs by 4% in 2013, 6% in 2014, in order to be more competitive. The panel members generally agree that competitiveness is key to each country moving forward. We can assume that there is pressure to keep labor costs controlled in each country to maintain their competitiveness.
So, by looking at the second equation above, if real hourly compensation falls and productivity is expected to rise, then labor share would have to fall even further. The result would be more profits for corporations. But there is an even more troubling problem. If you lower real compensation, you tend to lower demand. Yet, they already said above that the issue going forward is demand.
Hmmmm…..
OK… let’s hope that real hourly compensation rises at least in the United States. My view is that labor share has already anchored into an effective labor share of 73.4%. So labor share is now a constant. This is based on the following graph…
Graph #1
The lines come from an equation to analyze the relationship between labor share and the TFUR (labor utilization * capital utilization). The line goes to zero when effective labor share (els) and TFUR are equal.
Reflective Fed rate curve = els*(els-TFUR)/(1+TFUR)
The green line in graph #1 shows that effective labor share was anchored around 80% through all business cycles from 1975 to 2001. Since 2001, the line has shifted to the blue line, which now shows an effective labor share anchor of 73.4%. The point is that labor share is now anchored into the dynamics of the present business cycle and will be hard to shift up or down from here. The reason is competitiveness. As productivity grew, labor share dropped in order for business to stay competitive with real hourly compensation under control.
So, it will be hard to raise labor share due to a need for competitiveness. But then where is the demand going to come from? Ray Dalio (46:20 minute point) says that spending can be in money or credit. He says that if credit picks up, then money, meaning the liquidity in the system, can decrease. Central banks want to decrease the liquidity at some point to prevent inflation. While he says spending is the important thing, he basically says that the spending has to be balanced with the productivity growth rate. However, he also said that national income has to rise faster than debt. So there seems to be a problem in his argument, because he is pointing to the rise in credit/debt as part of the excess liquidity solution, but debt has to grow slower than income growth.
Now, if real hourly compensation has to be controlled for competitiveness, and labor share has already anchored in for this business cycle, then demand will somehow have to be increased with credit. However, as the economy starts to pick up, there will be a rise in some interest rates. We have already seen a rise in mortgage rates. A rise in interest rates related to purchases will be a headwind against demand.
Then, how does effective demand play into this? The problem is that effective demand is already putting a limit on productivity. I have already said above that labor share dropped so that productivity could be competitive by keeping real hourly compensation under control. Yet, there is a limit to how far labor share can drop, because effective demand also drops. And if effective demand drops all the way to real GDP, the economy will come to a screeching halt. Effective demand is already so low that we do have a new normal at a lower level of labor and capital utilization.
So labor share has found a niche to sit in… effective labor share anchoring in at 73.4% or so. The effective demand limit has anchored in. If labor share were to fall more, the economy would screech to a halt. If labor share were to rise, real hourly compensation would have to rise to keep productivity constant or rising. Yet, a rise in real hourly compensation will be difficult in an environment of high unemployment and global competitiveness.
Ray Dalio says that productivity must rise, but the only way to express an increase in productivity is through a rise in real hourly compensation. Labor share is already anchored in. Well then, this will be interesting. How many countries are going to raise their real hourly compensation?
In conclusion, there are many contradictions in what the panel members say. They are hopeful, but… the constraints of demand, credit, productivity, competitiveness and labor compensation are going to be very tricky to work out just right. The economy is in a delicate balance going forward. The question now lies in which countries will respond to social unrest with higher wages. And then how will business respond to maintain their competitiveness?
(Note: Competitiveness means profit maximization for corporations. Higher wages contradict maximum profits. Wages have been set according to the private costs of business, instead of the social costs of labor. Somehow societies will have to find a way to raise wages to a level corresponding to the social cost of labor. Meanwhile both Wal-mart and McDonalds are fighting the living wage.)
Source
HODMRD. Davos 2013 Bloomberg) No Growth, Easy Money The New Normal. youtube.com. 7/18/2013. Retrieved from https://www.youtube.com/watch?v=R90-qXhyw5E
Edward:
Davos does not undestand manufacturing. Direct Labor in manufacturing is not the issue. Look to legislated and customary Overhead.
I suspect you already know this and I will shut up.
Run75441,
They talk like they are hopeful, but when I look at their faces while another is talking, they seem worried. They sense there are going to be some really weird economic times ahead.
But go ahead and describe the overhead issue. I want to hear.
CBO today projects that labor will be getting a bigger share at the expense of profits , but from their graph it looks like it won’t start until ~2015 :
http://www.cbo.gov/publication/44433?utm_source=feedblitz&utm_medium=FeedBlitzEmail&utm_content=812526&utm_campaign=0
If your effective demand calcs hold true , it looks like we have a couple years of stagnant growth ahead of us , or worse.
I smell a new credit bubble brewing as a way to can-kick around that outcome , one last time , and then we’ll be not just toast , but scorched toast.
” Labor and sales are found globally. In effect, businesses can fulfill their demand and their general business plan globally.”
The above has been the entire model for “globalization”. It is why Walmart is growing while not doing so much in it’s home country.
Problem is, the model fails for the local economy. Not all business will become global. In fact, if there is one aspect of the good old days model it was that the local mega company was the end point for many more smaller feeder companies and then all the supporting activity driven off all those jobs (money velocity?).
Thus, the quoted statement’s problem is the problem with the dominate economic ideology. It only reflects those who make money from money. It uses a word that implies “all encompassing” (global and globalization) when in truth it is a rather small and exclusive aspect of an economy.
To put it another way, capital can globalize and thus profit sources become global until….it runs up against the fact that labor can not globalize. That is, you and I can not outsource our labor and then reimport our labor’s results and pocket the difference.
Econ has conflated the idea of seeking labor supply globally with labor moving globally. How the hell such smart people could not see this, that actual labor can not move as capital and thus play the arbitrage game is beyond me. No, migration is not globalization of labor.
And that is the demand issue.
Marko,
I am with you. The more I look at this, it is very likely we are going to see an increase in debt again but with stagnant growth, because the debt increase will be moderated.
Debt is already growing faster than national income in the UK.
Also, I always wondered about incomes in South Korea. Their strong economy must have good wages I thought. Until I learned they have high consumer debt levels.
The world is now structured to feed labor not with good wages, but with credit. And then business expects the government to provide services to low income workers, but then business does not want to pay taxes.
When Milton Friedman wrote that the social responsibility of business was to make maximum profits, he unleashed a disease on middle and low income people.
Daniel,
You make good points. and run75441 talks about the overhead costs too. I try to imagine an American working and living like the cheap labor in China. But still, many Americans would do it.
I taught in a university in Chile. I made a bit more than the average professor there. But my income came out to about $6.50/hour. Lower than the US minimum wage.
I knew a teacher who worked in China. She made 4 times the other teachers. And she was making $600/month. She said the other teachers were very envious.
One thing I hear about China is that when you go there, one of the first questions that people ask you is how much money you make. It is customary for them to ask that apparently, but not for us. We think it is offensive. There is a lot of unmanifested desire for better wages in China. They have a lot of strikes there. Did you hear about the US managers that get kidnapped by their workers until wage demands are met?
Well, all the smart people seem to have forgotten the teachings of that great communist Henry Ford.
Pay the workers five dollars a day (good money at the time) so they will be able to afford to buy cars.
I used to not understand this, because I can be pretty stupid at time. I wondered what good it did Ford to pay the higher wages in order to get it back selling cars to his workers… thinking zero sum. But Ford was smarter than me. If he paid HIS workers five dollars a day, other employers would have to raise wages in order to get people to work for them.
This used to be understood .. “prevailing wages” in government contracts, fairly high government salaries, pro-union laws, minimum wage laws… that is raise the wages of some workers and the rest will follow.
Big Business… not Ford… can’t seem to understand this. All they know is that if they squeeze their own workers they can increase their profits.
Maybe this is what Edward is trying to explain to them.
But they may have another game entirely. The ancien regime did not rely on high wages to labor to increase the wealth of the owners. They relied on raw power and a vast reserve of starving workers to become as wealthy as they could understand. I think we are going back to those romantic times.
Coberly,
We are definitely going back to those romantic times. Real wages can only rise now if productivity can rise. But that would only push inflation down now. This situation is really silly. The economy has boxed itself into a corner with no way out but like you point out… pay the workers more, then other businesses will have to follow, then production will increase and with it productivity. Productivity will increase because each worker will have to produce more to meet the increased demand.
Ford was brilliant, creative, wise and a great businessman.
I used to manage the finances of a sporting goods store. I was always pushing for greater pay through bonuses and incentives for the workers. There were about 35 employees, mostly young college students. We were the biggest store in town, so we could attract the best staff with higher wages. Our staff loved the bonuses.
Some of the other managers were skeptical of paying higher bonuses. I would study the cash flow carefully and tell them, “don’t worry. We have the sales to make it work.” And we did. Everyone was happy and the workers were more motivated. The workers were outdoorsy types and would buy store products with their extra wages.
but Walmart is simply being greedy. Walmart has a 3rd world mentality. When I lived in Chile, there was a store like Walmart called Lider. The wages were horrendous. Most workers got the minimum wage of about $300/month. The workers would constantly go on strike, but Lider would not raise their own wages even though they were the most profitable business. Lider knew people would shop there anyway because they had the lowest prices in town. Their attitude is… If you don’t like the low wage, leave. We’ll find someone else.
I worked for the customs agency in Chile too. The customs agents would tell me about products coming in from China. Lider would receive a pair of shoes for 600 pesos at the dock. A little over a dollar. Then they would sell the shoes for 10,000 pesos. $20. but there is more to the story. There were many small shoe stores in the towns. Lider would sell the cheap shoes to these stores at almost their own retail price in order for that the stores would have to sell the shoes a little above Lider’s prices. Lider and a few other stores controlled the market. The other stores were Falabella and Almacenes Paris.
As I was leaving Chile, the 3 main pharmacies were being charged for collusion in setting prices. It had been obvious for a long time that they were price-fixing. Finally the government was forced to take some action on it. I do not know how it turned out.
Wages can only rise by the application of labor power in the US,but of course labor has no power.. In other places to some degree government applies power to increase wages or a nod to the social contract or belief in some general good tends to raise wages or at least slows their decline. China perhaps demonstrates these things. Now pretty much absent in the West with the continued advance of what I call the ideology that is economics.
There are zero people in power who question the ideology and only a handful two or three degrees of separation from power who question it.
Then too with 7 billion humans living, energy flat lined and environmental degradation continuing apace it is: 1, sort of silly to think there is not enough demand, and 2, believing that if somehow the money and credit needed to boost demand could possibly flow to more of them the demand could be met by the planet.
Rapier
I am inclined to agree with you about the ability of the planet to meet ever increasing consumption.
But it is not beyond hope that we could learn to “consume” things that are not resource intensive.
Meanwhile increasing the ability of labor to demand a fair wage is a good thing… even for “the rich.”
Of course my idea of a fair wage is one that will pay for food, decent housing, medical care, retirement, education and enough leisure (and security) to actually enjoy living.
Note the absence of faster cars, bigger houses, cell phones, and Raiders jackets. From what I have seen, even on this site, folks making a hundred k don’t think they are rich enough to pay taxes, but demand “the rich” pay more taxes so “the poor” can have faster cars.