Productivity still very much stalled against the effective demand limit
Just a quick update to the productivity chart. (quarterly data, link to data)
What does this graph show? When the economy is approaching the effective demand limit (red line), productivity stalls. Then a move toward an economic contraction will release a productivity increase.
Note: The red line is the effective demand limit, where real GDP (Y) equals effective demand (E).
As one can see in the graph, it is normal for productivity, as measured by real GDP/total labor hours, to stall out and move horizontally to the left until it reaches the effective demand limit. And then the line will sit in one place for years.
It should not be surprising to anyone that productivity is constrained by demand. If productivity was to increase with the same labor hours, there would not be effective demand to absorb it. And if labor hours are reduced to increase productivity, the result is a reduced real GDP, not higher productivity. Why? Lower labor hours also results in less effective demand from lost wages. There is a zero sum balance between real GDP and effective demand in terms of labor hours, when real GDP gets close to effective demand.
When the line begins to move in a northeast direction, real GDP will rise in relation to labor hours and so will effective demand. That may seem like a good thing, but as the line starts to move in a northeast direction, an economic contraction begins to form. During a contraction, effective demand rises giving space for productivity to rise. (see when line balloons out to right and rises) An economic contraction is a price to pay in order to get increased productivity.
The line has not starting moving in a northeast direction yet.
Related article:
Lambert, Edward. Productivity really is demand constrained. Effective demand blog. 7/27/2013
“An economic contraction is a price to pay in order to get increased productivity.”
Why?
Productivity as charted above comes from a number of different areas. If I can increase my yield from 90 percent to 95 percent, I will increase productivity, in such a way that I do not need to run my equipment as many hours to meet demand – leading to what you suggest. If I invent a new kind of widget, I will generate new demand, hopefully at higher values per labor hour. If I open a new oil field, I can reduce the cost of widgets such that demand increases and more labor can be utilized.
Is your observation about contraction an empirical observation about how these have aggregated in the past? Or is it a more than that?
Will an increase in wages help…like raising the minimum wage? Higher wages will increase demand…yes?
Hi Arne,
The observation about productivity rising during a contraction is seen in the graph. When the blue line pulls away from red line, you are in a contraction. That is when productivity rises.
Demand constrains productivity growth. During a contraction, effective demand rises which gives space for productivity increases, which were previously constrained by demand.
Hi Jerry,
Yes, Higher wages would move the line northeast as happened in the late 90s. Productivity increases, yet effective demand has to increase equally too.
The blue line danced along the red line until the contraction took hold and then pulled away.
Productivity was not able to dance up along the red line before the crisis, because effective demand did not rise in relation to labor hours. Wages didn’t increase like they did in the late 90s.
So, you are right…
Productivity and contraction might not be associated if productivity gains were distributed to labor. Maybe they are connected because productivity gains are rarely/never shared with labor, or at least, predominantly in the US are not shared with labor.
Might be interesting to see different dot colors for different tax regimes.
“When the blue line pulls away from red line, you are in a contraction. That is when productivity rises.”
So this is an empirical observation rather than a modeled behavior. I note that it is not general, either. The years after 1997 showed an increase in productivity without a contraction.
“During a contraction, effective demand rises”
I think this is one of the reasons I am still having troubles with your results. Perhaps it is nomenclatural. I know that in a contraction people lose their jobs and we see a downward demand shock. So I have difficulty with something called effective demand increasing at the same time.
Does the value of effective demand really mean anything except during the periods that GDP is up against effective demand? If the process of moving toward the effective demand limit changes the effective demand limit, then how do I use the number?
Hi Arne,
Let me put it to you this way…
The inflation rate plus the spare capacity of the economy equals the inflated rate of effective demand.
So you can get an idea why effective demand rises so much during a recession. It is due to the great increase in un-used spare capacity.