THE BEAR'S LAIR Unproductive misery
By Martin Hutchinson
Productivity growth, the most mysterious of economic statistics, was announced
on Thursday for the first quarter of 2009 - revised upwards from 0.8% to 1.6%.
After a quarter century of stellar growth from 1948 to 1973, productivity
growth suddenly collapsed and remained low for the next decade. Then after
1982, it recovered somewhat, accelerating further slightly in the middle 1990s,
although still not to its 1948-73 level.
In 1997, Federal Reserve chairman Alan Greenspan famously used a mysterious
acceleration in productivity (later almost, but not quite wiped away by
statistical revisions) to justify growing money supply considerably faster than
would previously have been thought prudent. It's thus of great interest to see
what might have happened to productivity growth following last September's
collapse. The market took Thursday's figures as a positive signal. There is,
however, reason to believe it was a false one.
It cannot be over-emphasized that the productivity performance of the US
economy since 1990 has been solid but not stellar. From 1990 to 2008, according
to the Conference Board's Total Economy Database, labor productivity has
increased by 1.80% (2.05% in the bubble years since 1995). That compares with
1.27% in the sluggish 1973-90 period (1.00% in 1973-82) and 2.57% in the
halcyon years of 1950-73.
However, even slumping and despised Japan has done better since its bubble
burst, with 1990-2008 productivity increasing by 1.94% per annum. Moreover,
Britain has done much better, at 2.36% per annum. On the other hand, France and
Germany, at just over 1.5% annually, have done worse, as has Italy (0.93%) and
Canada (1.36%). US productivity has since the 1990s put on an adequate
performance, in other words, but no "miracle".
Examining broader multifactor productivity statistics gives a better feel of
the causes of productivity growth. Multifactor productivity, which looks beyond
just labor to include other production inputs such as materials and capital,
had quite a good year in 2008, growing 1.1%, slightly above the average of the
1987-2008 period. However, even more notable is the contribution of capital
intensity to labor productivity growth; whereas over the 1987-2008 period, it
contributed 0.9% annually, in 2008, it contributed fully 1.6% to reported labor
productivity growth of 2.8%.
Capital inputs to the US economy have almost doubled as a share of gross
domestic product since 1990. The productivity of capital usage has been in
steady decline since the 1960s, and has declined by a further 11% since
monetary policy was changed to permanent expansion at the beginning of 1995.
The past 15 years, therefore, have seen a modest increase in US labor
productivity growth, albeit nowhere near the level of 1948-73, which has been
caused by the surge in money creation and a substantial increase in the US
economy's capital intensity. In the late 1990s, most of the new capital came in
the form of Internet services and fiber-optic cable capacity, much of which has
served us increasingly well in the years since 2000; since the turn of the
millennium, most of the increase has come in the form of housing, of much more
questionable long-term utility.
Nevertheless, even in the last six months, exceptionally low interest rates
have caused a further surge in the capital intensity of the US economy, which
has had a further effect in increasing labor productivity (albeit mostly in the
unpleasant form of spiraling unemployment, since output has declined.)
Going forward, this trend will have to reverse. The cost of capital is clearly
in the process of increasing sharply, both through higher interest rates and
through the lower ebullience of equity and housing markets. This means that the
output from capital usage will also have to increase - the capital intensity of
the US economy can no longer increase, and must start to decline. From a purely
arithmetical viewpoint, therefore, it is most unlikely that labor productivity
can maintain the relatively satisfactory growth rates of the last decades, and
much more likely that it will suffer a reverse similar to that of 1973-82, or
possibly worse.
Tackling the problem now from the other end, there are a number of recent
changes which make me think that productivity growth will be much lower going
forward. For one thing, much of the growth of the last generation was in
financial services, which at their 2006 peak represented 40% of the earnings of
the Standard & Poor's 500 share index. By definition, if the financial
services business is capable of paying all those billions in bonuses to its
practitioners, it must be very productive indeed in order to generate the
necessary revenues.
We now know that much of the income on which the financial services boom was
based was illusory, that many of the services the industry provided were
detrimental to the nation's well-being and should not have been counted in
output, and that in reality we will be considerably better off with the
industry downsized and made to respect its betters. Still, that's a lot of
high-productivity jobs gone, a lot of high-productivity (if spurious) output
made to disappear. The downsizing of financial services alone is likely to have
a significant dampening effect on productivity growth going forward.
Another high productivity business that will be much smaller at least for
several years to come is housing and construction in general. Modern
construction employs huge amounts of capital as well as labor, so heavy
construction activity tends to increase labor productivity, even though
construction workers themselves have only modest value added. With an overhang
of properties in most residential markets, and an overhang of office space in
many city centers, it seems likely to be several years before construction gets
fully back on its feet, and both productivity and the capital intensity of the
economy will be lower while the industry struggles.
Conversely, the principal gainer from the turmoil of the last couple of years
is undoubtedly government. One does not need to be an ardent believer in the
superiority of the private sector (as I am) to note that the output of
government services is generally entered in the national accounts only at their
cost, without regard as to whether their value may exceed that cost. Thus
government's contribution is generally low, since output is increased only by
the cost of its inputs. Furthermore, there is very little scope to improve
government's productivity, even if that productivity improvement could be
measured other than through decreased costs, which would depress reported
output.
Besides the depressing effect that it will have on the rest of the economy, an
increase of 5% to 8% in the proportion of the economy taken up by government,
as seems likely, will thus depress productivity growth directly. I have
suggested in the past that economic analysts would do well to examine "gross
private product" – the proportion of output produced by the private sector and
therefore valued by market forces. In the coming years, with a state
health-care scheme and a "cap and trade" market-distorting carbon emission
permits scheme both in view, it seems overwhelmingly likely that gross private
product will show weak if any growth.
Finally, there are the direct effects of recent changes in the US economy,
which appear likely to involve higher real interest rates than we have been
accustomed to in the past 15 years and will certainly involve a lower degree of
leverage, in the household sector, the financial sector and the economy as a
whole.
Lower leverage increases the amount of capital necessary to support a given
volume of activity. It thus decreases reported labor productivity either by
increasing capital inputs or depressing output.
Higher real interest rates, which seem likely in order to ward off inflation,
have a more mixed effect on productivity. By lowering output in relation to
labor inputs, they depress it. On the other hand, by increasing the rewards to
capital, they ensure it is allocated more effectively, thereby increasing
productivity in the long run. The empty McMansions produced by the housing
boom, for example, may have looked very good in 2005's productivity statistics
as they were being constructed, but are depressing productivity now since they
add only costs and no rental or other revenues, while consuming capital inputs
through their depreciation. Long-term productivity growth requires the
minimization of unproductive investments made during bubble periods of one kind
or another.
Thus the qualitative consideration of recent developments in various sectors
tallies with the quantitative argument from examination of past productivity
developments. Take both arguments together, and you can see why reported growth
in productivity is likely to be far lower in the next few years than in the
recent past. Like the downtrend of 1973-82, the new downtrend will be difficult
to explain and may be prolonged. The likelihood of a prolonged period of
sluggish productivity growth is thus yet another reason to expect the 2010s to
be economically a miserable period.
Martin Hutchinson is the author of Great Conservatives (Academica
Press, 2005) - details can be found at www.greatconservatives.com.
(Republished with permission from PrudentBear.com.
Copyright 2005-2009 David W Tice & Associates.)
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