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.

prod & ED 6

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.)

prod growth

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.