THE BEAR'S LAIR Productivity's poisoned legacy
By Martin Hutchinson
First-quarter labor productivity growth in the United States, published by the
Bureau of Labor Statistics last Wednesday, was unexpectedly positive, with
non-farm labor productivity rising 2.2% over the previous quarter.
Wall Street mostly rejoiced at this number (the stock market was down, but
irrationality is the middle name of most short-term trading moves). However to
the impartial observer it was a very odd statistic indeed, for two reasons.
First, productivity generally declines going into a recession, as unexpected
cuts in output surprise companies that do not have time to lay people off (or
don't want to, in case output blips back). Second, the oil price is
now substantially above its real level after the 1973 oil crisis. Since that
episode ushered in a decade of exceptionally poor productivity growth in the
United States, why aren't we seeing the same effect now?
At present, there is little evidence for a productivity slowdown, although the
Bureau of Labor Statistics figures can be revised substantially several years
after they first appear. Multifactor productivity, the best measure of
productivity (since it takes account differences in labor's skill levels and
the capital intensity of the economy) rose by 1.3% in 2000-07, just slightly
above the long term average of 1948-2007 (1.2%) but well below the rate in the
halcyon years of 1948-73 (1.9%). To show the extent of the 1970s' slowdown,
multifactor productivity DECREASED by 0.3% in 1973-82, then increased by a
fairly steady 1.0% annually from 1982-2000. There was no significant
acceleration in the 1990s.
Multifactor productivity growth has in the past 40 years been considerably
lower than labor productivity growth because of the steady decline in the
efficiency of capital utilization. This capital productivity increased by 0.6%
per annum in 1948-66, but has declined by a fairly steady 0.9% per annum since
then, with a modest reversal in the 1980s. One can imagine why: the period
since 1966, with the exception of about a decade 1979-89, has been one of very
low or even negative real interest rates. In such an environment, when capital
is so cheap, it simply gets wasted.
Academics are not entirely agreed on the reasons for the productivity slowdown
of the 1970s, to put it mildly. Some such as William Nordhaus blame the oil
price spike and the need to reorient the economy to an environment of
permanently higher oil prices. Nordhaus points out that the productivity
slowdown was most severe in oil-related industries.
Others have noticed that service employment grew rapidly during the decade, and
that productivity growth in services was much less than in manufacturing.
Others attributed some of the decline to the entry of the idle and
self-absorbed baby boomers into the workforce. Finally there is the
environmental cleanup mandated at the beginning of the decade, with endless
resources being devoted to cleaning up healthily cooling sulfur emissions,
downsizing Detroit's finest products and finding new and previously unheard-of
species of newt to protect.
Similar productivity slowdowns occurred in other countries, suggesting that the
oil price rise, the only constant global factor, must have had something to do
with it, although in France and Germany socialist governments with sloppy
public spending policies, transferring resources to the public sector,
certainly bore some of the responsibility.
We can rule out immediately some of the possible causes of the 1970s
productivity slowdown as potential repeaters. The baby boomers are coming
towards the end of their careers, while today's kids entering the workforce are
a bunch of hard-working conformists with much better grades than their parents
and no significant drug or even alcohol habits.
The generational explanation for the 70s slowdown is even more attractive than
it at first appears, since you could also credit the productivity speedup of
the late 90s (to the extent it wasn't entirely a statistical fiction) on baby
boomers reaching their 40s and deciding it was time to straighten up, fly
right, and work on funding their pensions. Their disappearance from the
workforce into penurious retirement might be thought likely to increase
productivity further. However, generational effects are too easy an
explanation; the equivalent generation in other countries appears to have had a
significantly different upbringing and character, and yet productivity
slowdowns happened globally in the 1970s as well as domestically.
Service employment is more difficult to dismiss as a potentially recurring
factor. While services have become overwhelmingly the dominant feature of the
US economy, much of that growth has been in the financial services sector, with
such fields as mortgage origination and securitization taking a surprisingly
chunky slice of GDP. Since the only way to measure output of such financial
services is to calculate the fees charged for them, the significant increase in
the overall cost of mortgages since the 1970s has produced a substantial
nominal increase in output and a corresponding increase in reported
productivity (with the collapse of the savings and loan industry in 1989-92 and
the housing boom thereafter it represents a significant portion of the apparent
productivity speed-up of the 1990s.)
This should now go into reverse for two reasons. First, volumes of home sales
and home mortgages should be depressed for at least a decade. Second,
securitization has become a thoroughly suspect technique, suggesting that many
home mortgage originators will revert to direct lending, producing less
measured economic output but significant savings for the homeowner. At least
some slowdown of recorded productivity in this service sector is thus likely.
The oil and commodities price spikes are much more likely to cause downturns in
productivity, particularly if they persist for a while, even if reducing
somewhat from their peak. The United States uses less oil than in 1973, and
foodstuffs form a less important part of its budget, which has led commentators
to claim that oil and commodities prices cannot have the effect on the US
economy that they had in the 1970s.
However, there are two reasons to think that this is wrong. First, the oil
price rises of the 1970s occurred in two distinct episodes, in late 1973 and
1979-80, with a substantial period of quiet inflation for the US economy to
adapt to the first price-spike before the second hit. Second, oil prices at
$120 plus per barrel are now significantly higher than their 1980 peak, which
equates to about $103 in today’s money and was in any case short-lived (the
highest oil price that persisted for more than a few weeks was equivalent to
about $80 in today's dollars.)
While oil prices will probably descend from their heights as they did after
1981, there are a number of factors propping them up. Most important, the West
has now definitively lost control of the oil market. In the early 2000s, it
appeared that the emergence of major new production from Russia would finally
break the grip of the OPEC oil cartel. However Russia has instead inserted a
sinister new factor into the oil market, a player whose interests are not
congruent with those of consumers, but which derives a perverse pleasure from
making Western economies totter.
In addition, the percentage has risen of the world’s oil reserves controlled by
state oil companies, with at best 1970s' technology for complex exploration and
exploitation and often under control of megalomaniacs like Vladimir Putin,
kleptomaniacs like the rulers of Nigeria or Angola or simple maniacs like
Venezuela's Hugo Chavez. To counterbalance this, tar sands and even (at $120
per barrel) oil shale have come within the realm of practical extraction, but
environmentalism and Chavez's perverted ideology have prevented these sources
from being ramped up to the extent necessary.
This brings us to the final factor believed to be partly responsible for the
productivity slowdown after 1973: increased regulation. Detroit, which had
manufactured automobiles of great beauty with remarkable efficiency in the
1960s, found itself compelled to put ever increasing amounts of expensive
environmental fiddle-faddle in its products, and to redesign them around
Congress’s bizarre idea of how an automobile should perform (resulting in the
regulatory-loophole-driven SUV.) Steel plants and utilities were forced to
retrofit expensive pollution control equipment. Given the passage of the Clean
Air Act in 1970, it is quite clear that these regulations were a major factor
contributing to the 1970s productivity decline.
This factor is however still with us, and indeed about to be intensified.
Global warming may or not be real, but the economic effect of a "cap and trade"
carbon emissions control system certainly will be. The Corporate Average Fuel
Economy standards, which had been allowed to remain static since they produced
the SUV and halved Detroit's US market share in the 1980s, have recently been
intensified, again to the advantage of Asian producers of mini fuel-sippers and
against the interests of the US industry. If we get a Democrat president and a
large Democrat majority in both houses of Congress this November, we can expect
an intensification of regulation as the bureaucracy's wish-lists, thwarted by
presidential indifference since 2000 or even 1980, all get enacted at once.
There is another factor that will further depress productivity growth this time
around, which is trade protectionism. It is now clear that trade liberalization
agreements are impossible to pass either in the current Congress or its likely
successor. That will suppress globalization, which, aided by modern
telecommunications, has been the main factor increasing worldwide productivity
and lowering costs. Moreover, other countries seeing the United States turn to
protectionism will match it. Already the EU is attempting to extend the Common
Agricultural Policy beyond 2013, in spite of world food shortages and a price
environment that renders it entirely unnecessary for its original stated
purpose. Without forward progress on new trade agreements, existing
arrangements may well fall apart in an orgy of special favors and
"anti-dumping" lawsuits.
Finally, capital will probably become more expensive in the years ahead, as the
US works its way out of the current mess and savings rates are at least
partially restored. That will make capital productivity once more rise, as it
did in 1948-66. The reversal will probably have little effect on multifactor
productivity but will lower reported labor productivity growth, as more of the
gradual improvement in multifactor productivity will come from more-effective
usage of capital and less from labor efficiencies.
With at least two of the four factors thought responsible for the 1970s'
productivity slowdown in place, an additional factor in protectionism that
wasn’t present in the 1970s and a reversal in capital costs tending to lower
reported labor productivity growth figures, reported labor productivity
increases will in the coming years fall far below what we are used to.
Just as president Bill Clinton bore little responsibility for the apparent (and
largely spurious) increase in productivity growth in the 1990s but nevertheless
took the credit, so whoever is in power after 2009 will be blamed for the
decline in apparent productivity growth, even though he or she will bear at
most a modest portion of the responsibility for it.
The upcoming presidential election isn't one I'd want to win!
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 2005-07 David W Tice & Associates.)
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