2 Snippets to watch… World Trade & Productivity

World Trade weakens in Early 2014, Wall Street Journal:

Weakening world trade is something to watch according to Michael Pettis.

“… redistributing income downwards is easier said than done in a globalized world, especially one in which countries are competing to drive down wages. The first major economy to attempt to redistribute income will certainly see a surge in consumption, but this surge in consumption will not necessarily result in a commensurate surge in employment and growth. Much of this increased consumption will simply bleed abroad, and with it the increase in employment.

Less global trade, in other words, will create both the domestic traction and the domestic incentives to redistribute income. In a globalized world, it is much safer to “beggar down” the global economy than to raise domestic demand, and so I expect that there will continue to be downward pressure on international trade.”

Until we understand this do not expect the global crisis to end anytime soon, except perhaps temporarily with a new surge in credit-fueled consumption in the US (which will cause the trade deficit to worsen) and more wasted investment in China (which, because it is financed with cheap debt, which comes at the expense of the household sector, may simply increase investment at the expense of consumption). These will only make the underlying imbalances worse. To do better we must revive the old underconsumption debate and learn again how policy distortions can force up the savings rate to dangerous levels, and we may have temporarily to reverse the course of globalization.

Grand Central: Time to start worrying about the US productivity slowdown, Wall Street Journal:

Productivity growth in the US has been slow for 3 years. It will eventually rise again but only as effective demand rises. Here is a graph plotting US productivity against effective demand since 1967.

update productivity

The graph shows that productivity always stalls out as the economy gets close to the effective demand limit per labor hour. This effective demand limit needs to rise for productivity to start rising again. Yet, this process can trigger an economic contraction by way of tighter monetary policy. The article by WSJ says…

“In the short-run, less productive workers means slack gets taken up quickly, which could in turn create inflationary pressure and force the Fed to start raising interest rates sooner than expected.”

The Fed is watching inflationary pressures very closely as employment of capital and labor increase.

The graph says that if real GDP per labor hour starts to increase, effective demand limit per labor hour will have to increase at the same rate or more. Productivity is demand constrained. Here is an equation for productivity…

Productivity = Real hourly compensation / Labor share

In order for productivity to increase, real hourly compensation must rise faster than labor share. Right now labor share is at its lowest point since WWII. So there has been an attempt to raise productivity by lowering labor share. But when that is done by simply lowering real hourly compensation, productivity does not move. One would hope that labor share would rise back up, but it may continue to fall too. If labor share falls in relation to real hourly compensation, productivity will rise. Yet a fall in labor share would lower effective demand which is already constraining productivity. Productivity would want to fall if labor share fell anymore at the moment, due to the effective demand constraint.

The key to raising productivity, when it is stalled like now, is to keep increasing real hourly compensation until labor share begins to rise, but at a slower rate. We may see some inflationary pressures, but that would be good. It makes sense to raise minimum wages. Then we won’t have to worry so much about productivity.

It is important to watch productivity as we move forward.