productivity diffusion

Happy Friday the thirteenth!

The Financial Times has an article today that talks about productivity diffusion, referencing a prior FT article and an OECD study on the topic, both of which I somehow missed.

In its simplest form (which suits me fine), economic growth can be broken down into two components:  having more workers (or having existing workers put in more hours); or being more productive, meaning investing in machines, new business processes or worker training.

One of the bigger economic issues facing the world (US included) is the sharp dropoff in productivity growth over the past ten years or so.  The OECD report that sparked the FT articles argues that the problem isn’t a drop in innovation across the board.  Rather, the most productive firms in the world continue to show strong productivity growth.  What’s changed is that the once-fast followers are only adopting best practices today at a much reduced rate.

Why is this?  The OECD answer, which best fits the EU, I think, is that big banks are protecting low-growth, heavily indebted “zombie” firms.  Their reason?  The banks keep the zombies afloat (mixed metaphor, sorry) so they won’t have to write off the dud loans–calling into question the banks’ own financial viability.  What’s scary about this analysis is that it calls to mind the experience of Japan in the 1990s, the first of that country’s three lost decades.  Given that the Tokyo government actively protects managements from the consequences of failing to innovate, the problem of economic stagnation still afflicts Japan today.

To me the real relevance of the current lack of productivity diffusion for the US is that it speaks to the thrust of Donald Trump’s macroeconomic ideas.  However well intentioned, the effect of dissuading firms from adopting productivity enhancing measures for fear of being publicly shamed and of shielding non-competitive firms from import competition will likely be the zombification of the affected portions of American industry.  That is not a long-term outcome anyone wants.

 

is 4% real GDP growth possible in the US?

the 3% – 4% growth promise

One of Donald Trump’s campaign promises is to create 3% – 4% GDP growth in the US.  Is this possible?

The first thing to note is that this is real GDP growth, meaning after inflation has been subtracted out.  I’m not sure Mr. Trump has ever clarified this–or that he wouldn’t be nonplussed by the question–but his appointees to head the Treasury and Commerce departments have said real is what they mean.  Also, 4% nominal (that is, including inflation) growth is about what the US has been churning out in recent years.  So promising 4% nominal growth would be like P T Barnum putting up his “This way to the egress” sign.

where does growth come from?

Simple models are usually the best (as in this case, feeling embarrassed when calling them “models” is a good indicator of simplicity).  Growth can come either by having more people working or by having workers be more productive, meaning churning out more output per hour.

more workers

Having more people working is a function of demographics.

Each year, the population of the US rises by about 0.8%.  Half of that comes from children being born to people already residing in the US; half comes from immigration.  If we take increases in the population as a proxy for increases in the workforce, then demographics can generate a bit less than 1% trend growth in GDP.

This also means that if Mr. Trump carries through on his threat to deport 3% of the workforce and restrict entry of immigrants, not only will the social consequences be shameful, he will make it that much harder to achieve his GDP objective.

productivity

Given that demographics will likely either not change, or will change in a negative way, getting to the low end of the 3% – 4% range will only be possible if worker productivity rises.   Let’s make the optimistic assumptions that the Republicans’ white supremacy rhetoric doesn’t discourage any potential immigrants and that there’s no increase in deportations.  If so, productivity gains would have to be at least +2.2% per year to achieve the low end of the GDP growth goal.

If +4% growth isn’t simply “marketing” in the worst sense of that word, the Trump camp must believe that productivity can be boosted to +3.2% per year.

An aside:  My first stock market boss was a vintage 19th-century capitalist.  He believed that increasing worker productivity meant boosting the workload–and making employees work longer hours for the same pay.  (No, there was no company store where we were forced to buy meals; yes, we had to basically provide our own office supplies.)

That’s not correct, though.  Productivity improvement comes through better employee education/training and by employers investing in labor-enhancing machines (back then, it would have been computer workstations, or in my firm’s case, pencils).

productivity today

Productivity today has been stuck at around +1% per year growth for about a decade.  During the housing bubble, when the US was furiously churning out many more new dwellings than the country could afford and banks were making crazy no-documentation mortgage loans (websites were also sprouting up to show low-income renters how to buy a house and scam the system for a year of “free rent” before foreclosure), we got to maybe +2.8% for a number of years.  But the last time the US rose above 3% was in the 1950s, when industry in Europe and Japan had been destroyed by war.

my take

I hope Wilbur Ross can do what he says.

I think +4% growth is simply hype–and that Mr. Ross, if not Mr. Trump, knows the situation.

The trend in manufacturing is to replace humans with robots. That’s the most straightforward way to achieve productivity gains. Output climbs steadily; output per worker goes up faster.  However, the number of employees shrinks drastically.   For many displaced workers supporting Mr. Trump, this may be a case of being careful about what you wish for.

 

 

 

 

 

why productivity matters

This morning the Labor department issued its report for 2Q16 on productivity and costs.  The release shows that productivity in the US dropped for the third quarter in a row, coming in at -0.5% at an annual rate.

Why does this matter?

what productivity is

Productivity is a measure of the amount of output the average worker produces in a given period of time.  The government gets its aggregate figure by dividing its estimate of real output during a period by its estimate of total hours worked.

why it’s important

In broad terms, GDP can grow in two ways.  Either there can be more people working to make stuff, or workers can become more productive, that is, make more output per unit of time.

Worker productivity is not boosted by exhorting employees to make superhuman efforts from 9 to 5, as at least one of my former bosses firmly believed.  Instead, productivity increases come either from capital investment that provides workers with better tools or from workers getting training/education that allows them to work smarter.

consider Japan,

the poster child for advanced country GDP dysfunction.  The domestic workforce there is shrinking by about 0.7% per year.  So the country has to increase the productivity of existing workers by the same amount simply to prevent GDP from falling!

If we assume that continuing capital investment can increase productivity by 1.0% a year, which for Japan would be saying a lot, the country is locked into at best a miniscule 0.3% long-term annual GDP growth rate.  In other words, it is perpetually teetering on the edge of recession.

There’s no evidence of any increase in the Japanese birth rate;  in fact, it has been going in the other direction for a long time.  One obvious solution to stagnation is to allow immigration.  However, Japan has a xenophobic aversion to admitting foreign workers.  It’s opposed to allowing women having a significant role in corporations, too.   So it remains stuck in the same economic rut it has been in since 1990.

as for the US…

Just as the shoot-yourself-in-the-foot actions of the Japanese central bank in dealing with that country’s first decades (tightening policy too soon and nipping recovery in the bud), its response to its demographic dilemma should also be a cautionary tale for the EU and, ultimately, for the US.  In both areas, the same demographic forces are at work, though at a less advanced stage–and with the work force younger in the US than in the EU.

measurement problems?

In the early days of the personal computer era, productivity statistics showed the same kind of lackluster progression that they are exhibiting at present.  That turned out to be a problem with how productivity was being measured.  Maybe the same will turn out to be the case with the technological change the internet is bringing.  Or it may be that in creative destruction, the second part comes first.

a practical application

The long-term growth rate of the US economy is now about 2%, comprised in roughly equal parts of growth of the workforce and productivity increases. The Republican economic platform maintains that the GDP growth rate of the US can be doubled by:

–lowering the number of foreign workers who can enter the US and compelling, say, 5% of the current workforce to leave the country, and

–reintroducing obsolete 1970-era tools to American factories, attempting to create a domestic market for output by placing high tariffs on imports of modern products.

I’m not sure how fewer workers + older equipment = growth.  More immigration + worker training/retraining might be better.

worrying about productivity

getting GDP growth

Looking at GDP from a labor perspective, growth comes either from having more workers or from more productivity, that is, from workers creating more stuff per hour on the job.  (Yes, you can get more output by not letting workers go home and forcing them to work 100 hours a week.  But that’s not going to last long, so economists generally ignore this possibility.)

The trend growth rate of the population in the US is, depending on who we ask, somewhere between +.7% and +1.0% per year. For reasons best known to itself,  Congress spends an inordinately large amount of time, in my view, devising ways to keep a lid on this paltry number by prohibiting immigration.  So, as a practical matter, the only way to get GDP to expand in the US by more than 1% is through productivity growth.

 

The weird thing about productivity is that it’s a residual.  We don’t see it directly.  Productivity is a catchall term for the “extra” GDP that a country delivers above what can be explained by growth in the number of people employed.  Economists figure it’s the result of employers providing better machinery for workers to use, technological change, and improved education + on the job training.

Productivity peaked in the US shortly after the turn of the century at around +2% per year, accounting for the lion’s share of national GDP growth.  It has been falling steadily since.  Over the December 2014 and March 2015 quarters, productivity dipped into negative territory.  This is hopefully a statistical quirk and not the sudden onset of mass senior moments throughout the workplace.

why worry?

Over the long term, the disappearance of growth through productivity gains implies economic stagnation in the US.  (My personal view is that the productivity number are the aggregation of a highly productive tech-oriented sector and a low/no-productivity rest of us hobbled by a weak public education system   …but, as a practical matter, who knows?   By the way, productivity figures don’t include government.)

The more pressing issue is that no productivity gains means employers aren’t finding ways to make their employees create more output per hour worked.  That is, they have no way of offsetting  higher wages other than to try to pass costs on by raising prices.

the bottom line for investors

Conventional wisdom is that the Fed will take a long time to shift from extreme economic stimulation through emergency-low interest rates back to normality.  Both stock and bond prices also seem to me to have imbedded in them the idea that “normal” will be lower in nominal terms than it has been in the past.

A bout of inflation induced by rising wages could change that thinking in a heartbeat.

To be clear, dangerously accelerating inflation isn’t my base case for how the economy will play out.  And no one is thinking that the US will only grow at about 1% annually from now on.  All the more reason to keep a close eye on how productivity figures evolve.