Increasing productivity by cleaning out low-productivity firms
In the Solow Growth Model, productivity is a powerful factor for raising income per person in a country. So it is important to maintain productivity growth if a country would like to have economic growth.
I have written recently that there are ways to discipline the market in order to achieve greater productivity and thus greater net social benefits. We could raise the minimum wage or raise the Fed rate. What would the result be? Low productivity firms get cleaned out leaving high productivity firms still in business.
There is a post at the Growth Economics Blog on this very issue. The post refers to a paper titled, Reallocation in the Great Recession: cleansing or not? The paper says that low productivity firms normally get cleaned out during a recession, which allows productivity to increase after a recession. But that didn’t happen after our recent crisis. So there is evidence that low-productivity firms are still in business.
So why didn’t low-productivity firms get cleaned out this time? As the Growth Economics Blog’s post says…
“The authors don’t offer an explanation, as their paper is just about documenting these changes.”
Well, some of the answers to this question are simple. If you keep real wages low, low-productivity firms have a better chance to survive.
This graph uses show real compensation (blue) and productivity (red). From the graph, we see that this is the only business cycle so far where real compensation has not risen. You can also see a correlation between productivity and real compensation. By the way, productivity rose greatly back in the 50’s and 60’s, and look how steadily real compensation grew through the recessions back then.
Then we can look at the Fed rate.
This is the only business cycle where the Fed rate has not risen to challenge low-productivity firms. Productivity has a delayed response to an increase in the Fed rate due to a subsequent process of cleaning out low-productivity firms, usually in a recession.
One would think that if the Fed rate was truly tight for market conditions, we would have seen more low-productivity firms get cleaned out. But the continued existence of relatively more low-productivity firms supports the view that the Fed rate has not been tight and therefore not disciplining low-productivity firms.
Also the banks want low-productivity firms to stay alive because the banks are protecting their own capital ratios.
So these two processes of challenging low-productivity firms, higher real wages and a rising Fed rate, have been excessively weak so far in this business cycle. The result is a weaker economy.
The NBER paper linked by the Growth Econ blog post is behind a paywall, so I can not tell whether I believe their evidence that low-productivity firms are not exiting. I do find the assertion that a low job creation rate implies peope to be pinned to low productivity jobs a bit of a stretch.
The mechanism of competitioin still exists regardless of whether capital is less costly. It still exists regardless of whether we are at the effective demand limit. If consumers are only going to buy so much stuff, then firms will want to be the ones able to sell.
I did not read this whole post last night because I was too tired. So, I did have some muddled thinking about what you have written in the past.
From another post you say “The Fisher Effect says that inflation will decline with lower nominal rates in order to seek the natural real interest rate equilibrium.” If I look at Wikipedia I get “the real interest rate is the nominal interest rate adjusted for the effect of inflation on the purchasing power of the loan proceeds”. The cause and effect are not clearly the same.
Of course, economics is rife with hard to understand feedback effects, so maybe there is not a contradiction. However, Krugman’s discription of the liquidity trap (if I am getting it right) depends on the Fisher Effect where the nominal rate is driven by the desired real rate and inflation. If the nominal rate would need to be zero or less, then we are at the zero lower bound, we are in a liquidity trap, and the Fisher Effect will not hold.
I believe that the conclusion is that at the ZLB, raising the fed rate will not have the effect you predict.
Hi Arne,
There is a difference between the real rate and the natural real rate at full employment.
The real should start out lower than the natural rate after a recession. Then the real rate should rise to the natural real rate as the economy heads toward full employment. I say we are very near full employment now. Most economista who do not acknowledge an effective demand limit see 3% growth for a couple of years. I see growth slowing to below 2% over the next year. Thus I see that the real rate should be close to its natural rate of 1.8%, or thereabouts.
A natural rwal rate is optimum and ideal at full employment. It gives better social benefits.
The real rate now is less than -1%, because the Fed is întervening in the market by setting the base nominal rate at the zlb. Yet the economy is finding another way to raise the real rate to its natural rate by lowering inflation. So the Fisher effect is holding at the zlb.
It sounds like it’s time to raise the minimum wage and hope it goes high enough to wipe out some low productivity firms.
get rid of low pro firms increasing labor force available (unemployed),lower many basic jobs to min wage(time sensitive- wage cuts), vulture pressure increases productivity further, temporarily, demand drops here we are again, i.e. beatings continue until…..
Perhaps one day workers will be kept, in the entry until a number of customers enter and return to the waiting entry point when number of customers drop (computer tracking all the way) pay only for active (in store) activity
Maximum retail productivity.
If only all of us could live off the interest.
Can’t we make an assumption that the higher the level of productivity, the higher will be the unemployment rate (or the lower the level of grass-roots recompense?)
The past forty years has been a procession of lowering pay and weakening labour, as technology and globalization have cleared out firms and sectors with lesser productivity. And now, we are being told we need yet more productivity?
High productivity is only a blessing if its effect is to benefit us, not to make us expendable.
I’m copying a comment I made based on the same paper on Economistsview:
“Job destruction rates rise appreciably, but job creation rates remain about the same.”
Question – was this ever really true? I have struggled to find long term figures on this – but this general argument from here (Ed Lazaer) – I thought was the standard story of labour economists:
http://www.realdailybuzz.com/rdb.nsf/DocView?Open&UNID=639d703c200eb2df85257d390082bfc0
“The low levels of churn in recessions mean that workers get stuck in the wrong jobs and produce less than they could in a better labor market.
One might expect that hires would fall and separations would rise in recessions, with the opposite occurring during booms.
Not so. There are lots of hires in booms but also a large number of separations; and in recessions there are lower levels of both hiring and separations. Believe it or not, hires and separations move together, not in opposite directions.
There is a reason.
Separations fall during recessions because quits fall and layoffs level off. When the labor market is strong, quits are generally high.
In the good years that preceded the recent recession, quits exceeded layoffs — by about 1.2 million per month. Workers quit to move to better jobs when the labor market is strong.
In a recession, however, quits decline and layoffs rise initially. During the worst month in the recent recession, for example, layoffs exceeded quits by almost 900,000.
Eventually the number of layoffs also declined — but quits did not rise because hiring was slow. Thus, as was typical in this and previous recessions, separations declined along with hiring. Because hires are so large and variable, net job creation depends in large part on what happens to hires.
It is impossible to generate job growth by reducing layoffs because once that channel is exhausted, nothing more can be done.”
Look, I’m sorry Lambert, but I can’t agree with you. Getting rid of low productivity firms is the job of competition, not of the Fed.
Reason,
Of course, getting rid of low-productivity firms is not the job of the Fed. Raising real compensation is a much more constructive way of doing it. The Fed actually does not want to get rid of any firm. But the Fed rate in the past has had to reach its long-run equilibrium rate at the end of a business cycle. Then the natural creative destruction process of a recession works its magic to make the economy better after the recession. But the Fed must follow the natural path of rising rates, which it is not doing.