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September 23, 2006

Delong on Productivity.

Brad Delong takes issue with a particular piece of silliness over productivity and Say's Law. Excellent.

P. 10 ff: The increasing division of labor with its consequent rise in labor productivity has at least one immediate negative effect: a reduction in the demand for labor in industries undergoing rapid rises in productivity. The reason for this is that the increases in the productivity of labor may run ahead of the widening of the market. Even though more units of the product are being produced and sold, if labor productivity is rising ever faster, fewer workers will be required to produce the output, and unemployment can result.

As Delong points out, those industries with strongly rising productivity seem, like Silicon Valley, to increase, not decrease employment. However, as is also pointed out:

The assertion that a belief in the theoretical truth of Say's Law--in the efficiency of financial markets--is necessary to support the claim that the market system is for the general good. Say's Law certainly does not hold anywhere in the short run. That's why we have the Federal Reserve--an island of central planning in the middle of our economy to try to ensure that even though Say's Law does not hold in theory in the short run, we can make a not too intolerable approximation to it hold in practice.

Ah, short term and long. OK, I'm not an economist, simply an interested amateur, but I think that this short term thing can explain one of the great puzzles of the US economy over the past few years.

Productivity is rising strongly. Wages are not (even wages plus benefits are only rising slowly, at much less than the rate productivity is) and the result of this is that corporate profits are rising strongly (hey, the extra cash has to be going somewhere, right?). Now, we do expect wages to rise with productivity but there has to be a mechanism: we don't think that bosses raise wages out of the kindness of their hearts now, do we?

So, in a paper from John P Lipsky and James E Glassman (no, not that James Glassman) from 2004 we get these two quotes (not online as far as I know, in Flying on One Engine from Bloomberg Books):

In particular, total employment will not expand unless the economy grows faster than businesses are able to boost productivity. Thus, the 'hurdle' rate for job growth-that is, the minimum rate of GDP growth needed to produce net job gains- will vary over time, depending on how successful companies are in improving their productivity.


If this did not happen-that is, if productivity continued to advance at the exceptional pace of the past year or so, the implication is that profit margins would soar, despite a starting point of record highs.

As Jared Bernstein tells

Let us begin with a few observations:

·  Over the course of the current economic expansion, real GDP is up 15%.
·  The Congress is busy killing a moderate minimum wage increase while working diligently to repeal the estate tax.
· Profits as a share of national income are at a forty-year high. The share of income accruing to the top 1%, after falling in the wake of the dot.com bust, is again on the rise.
·  Productivity is up a stellar 15% over this recovery.  Real hourly wages of non-managers are up bupkes (-0.6%).
· New economy cheerleaders expound on the great job market, yet employment growth is up only 2% over this business cycle. The growth for the comparable period over the 1990s cycle was 7% and the historical average for cycles of this length was 10%.

The confusing bit of all of this is seeing leftish economists running around trying to make sense of this great conundrum. That productivity is up but wages and job creation are not. But we appear to have a simple explanation. That in the short term strong rises in productivity, most certainly if they are greater than GDP growth, should in fact cause this very situation, along with rises in corporate profits. What do we have? Very strong rises in productivity, at and sometimes greater than GDP growth, weak job creation, not much movement in combined wages and benefits and strongly rising corporate profits.

We might add another supposition, that we can get into a series of J curve like things, where while last year's productivity rises might be expected to feed through into wages, this year's further rises stop that from happening.

Where's the difficulty? Theory predicts it, the real world seems to be bearing out the predictions of the theory, so why all this yodelling about Bush and the corporate executives screwing the working man?

As to solutions, well, there might be two. We can try and get even faster GDP growth but I'm not wholly convinced that anyone would argue for greater fiscal stimulus in the US right now. Or we could try to slow down productivity growth which, umm, sounds really like a very stupid idea.

Clearly there is something wildly wrong with this idea because such clever men as Paul Krugman, Jared Bernstein and the rest  have already considered this obvious point and rejected it for some reason that I, as a mere amateur, am unaware of. Could anyone tell me what that reason is?

Something more substantial than making political points is to be hoped for.

September 23, 2006 in Economics | Permalink


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Isn't this a temporary disequilibrium? Say technical change makes capital-labour substitution more attractive. Firms with modest demand expectations would respond to this by shedding labour rather than by expanding. So, unemployment and profit margins rise.
Eventually, however, this greater profitability should encourage either existing firms to expand or new ones to move in. That would bid up demand for labour and bid down profit margins.
I'll agree that workers are exploited, and CEOs have too much power - but that would be the case even if the macro labour market data were different.

Tim adds: Better expressed but yes, that's pretty much my view. Temporary....the bit about the J curves is there to point out that we can have a series of such in a row.

Posted by: chris | Sep 23, 2006 10:51:41 AM

One possible solution would be to get rid of central banks. The market would react quicker and Say's Law would hold true.

Posted by: Kit | Sep 23, 2006 12:12:59 PM

"total employment will not expand unless the economy grows faster than businesses are able to boost productivity"

This may be the reason why our society can & does support about 25% of our workforce in the public sector - not so much to provide services as to provide jobs. The problem being that the taxes that pay for it come, in part, from business thus slowing their ability to invest & increase productivity.

Posted by: Neil Craig | Sep 23, 2006 1:34:42 PM

As technology increases productivity, the jobs which are created become more technical. Here in Milwaukee there is an unfilled need for more CNC programmers and centerless grinder operators, and a plentiful supply of unemployed ditchdiggers.

Posted by: triticale | Sep 23, 2006 2:15:04 PM

One explanation playing a role here is the large
shift of profits from the new technology firms in the 1990s that very quickly turned around and reinvested the profits to the oil and other natural resource firms this cycle. The oil firms are being very slow to reinvest their profits, especially in the US.

Posted by: spencer | Sep 23, 2006 5:31:13 PM

Isn't it just simple capacity utilisation? The 2001-2003 downturn was in effect a drop in US industrial production in order to work off a inventory overbuild - itself largely due to over-optimistic forecasts of a boom (aided and abetted by Y2K hysteria). The drop in output did not produce large scale lay-offs or factory closures since it was known to be temporary. This meant that when output recovered there was a rapid gain in "Productivity" as every extra unit of output went to the bottom line. The conventional wisdom is so obsessed with demand shocks (usually associated with a, now much reduced, credit cycle) that they fail to notice the importance of supply. Now of course we have employment and wages growing and productivity "falling".

Posted by: Mark T | Sep 27, 2006 2:39:41 PM