THE
BEAR'S LAIR The unproductive
years By Martin Hutchinson
Multifactor productivity data from the
United States, announced to little fanfare last
week, showed a sharp downward revision for
2008-09, with a net fall over the two years. The
five-year period 2005-09 had the lowest average
multifactor productivity growth of any
quinquennium since 1978-82, at a beggarly 0.2% per
annum.
Lovers of the current economic
order like to trumpet the recent high labor
productivity figures, but when multifactor
productivity is considered, it becomes clear that
the US economic engine has become seriously
distorted. As so often in US economic questions,
the distortion's cause traces back to the same
root: the increasingly misguided sloppy money
policies of former Federal Reserve chairman Alan
Greenspan and his successor, Ben Bernanke.
When commentators refer to "productivity",
they usually mean
labor
productivity, the amount of output produced by one
unit of labor. US labor productivity has risen at
a decent clip in recent years, mostly because of
layoffs by companies outsourcing production to
emerging markets. Indeed, that rise in labor
productivity has been a hidden cause of the
sluggish employment growth since the bottom of the
recession. However, if you really want to look at
the productive efficiency of the US economic
engine, you need to look at multifactor
productivity, which measures the change in output
per unit of combined capital and labor.
Here the picture is much less favorable.
Multifactor productivity rose only 0.1% in 2009
and on revised data fell by 1% in the previous
year. The very low 0.2% annual rise in the 2005-09
quinquennium had a real effect on output. With the
average annual multifactor productivity growth
since 1948 having been 1.17%, we can legitimately
say that if multifactor productivity in 2005-09
had risen at its long-term annual rate, output in
2009 would have been 4.9% higher. Shortfalls in
multifactor productivity thus have to be taken
very seriously indeed; in the long term, they can
have a major and very unpleasant effect on living
standards.
The difference between labor
productivity and multifactor productivity does not
appear to be well understood by policymakers. In
the late 1990s, for example, Greenspan proclaimed
a "productivity miracle" because labor
productivity was increasing somewhat faster than
the 1980s-90s average (although still below the
rates of increase of the halcyon postwar period of
1948-73).
However, when you look at
multifactor productivity, you discover that during
the 1995-2000 period it increased at 1.12%
annually, slightly below the 1.17% postwar
average. Thus the "productivity miracle", and the
over-expansionary monetary policy that resulted
from Greenspan's perception of it, was simply a
mirage - the only real change in those years was
that an ever-increasing supply of capital was
being stuffed into investment in the technology
sector and telecoms.
There have been two
multi-year dips in multifactor productivity growth
since the series started in 1948; the other was in
1979-82, when it declined for four successive
years. The reasons for the dips become very clear
when you look at interest rate trends and the
business cycle.
Recessions tend to make
growth dip, with a sharp recovery in the years
following the recession. The negative figures in
1969-70 were thus followed by a recovery in
1972-73; that in 1974 was followed by a sharp
recovery in 1975-76. However, 2005-2008 were not
years of recession; hence the slower growth in
those years must have been due to some other
factor.
When you look at the sharp decline
in 1979-82 and the sluggishness in recent years,
the true culprit becomes clear: the level of
interest rates. In 1979-82, following then Fed
chairman Paul Volcker's 1979 "October surprise",
real interest rates were very high. That not only
reduced the level of capital applied to the
economy, it also made obsolete a high proportion
of the existing capital stock. For example, not
only did the steel mills of Youngstown, Ohio go
bankrupt, but the entire capital stock of the
Monongahela Valley region was devalued - housing,
shopping centers, offices, the lot - as former
steelworkers were compelled to move and the assets
that served them no longer had sufficient uses to
give them value.
Demand for labor, on the
other hand, remained high in the areas of the
country that were not suffering from bankruptcy of
their capital stock, in particular on the East and
West Coasts. Once the recession lifted, therefore,
job creation was exceptionally buoyant. This
time around, the redundancy effect has damaged the
labor rather than the capital factor in the
economic equation. Job loss levels in the winter
of 2008-09 were far above those of any recession
since the Great Depression, and the level of
long-term unemployment is far above that of the
early 1980s, especially when you take into account
the legions of "discouraged" workers who have
exhausted their benefits and dropped out of the
statistics. Even before the latest recession,
demand for labor was sluggish and workforce
participation rates were below those of the late
1990s, although the surge in employment in
construction, mortgage banking and real estate
sales disguised this effect.
Extreme
levels of interest rates thus adversely affect
multifactor productivity, and the rate at which
technological advance translates into living
standards. If rates are too high, capital stock
that would otherwise remain in use is made
redundant, new investment is choked off and
productivity growth slackens as the economy
operates sub-optimally.
Similarly, if as
at present interest rates are too low, workers who
would otherwise have remained productive are
forced into long-term unemployment and the economy
again fails to produce the increases in living
standards that it should - with 4.9% of GDP going
missing in the 2005-09 period. If you examine the
detailed productivity breakdown, you discover that
capital factors formed a record high percentage of
total factor inputs in 2009, again suggesting that
the economy was out of equilibrium.
Once
interest rates return to normal levels - a real
return of 2-4%, rather than a negative real
return, as at present, or real rates in the 5-10%
range, as in the early 1980s - multifactor
productivity will presumably return to its
long-term trend growth level. It should be noted,
however, that from the 1983-84 experience there is
only a modest level of "catch-up" following a
productivity dearth, so that a certain amount of
living standards improvement will have been
irretrievably lost.
This therefore is the
cost of Bernankeism. Just as sloppy monetary
policy in the 1970s and the squeeze that proved
necessary thereafter lowered sharply the robust
1.9% annual multifactor productivity growth of
1948-73, so Bernankeism and the likely squeeze
that will be necessary to remove the inflation it
is causing will result in permanent multifactor
productivity shortfalls, and very possibly a
reduction in its long-term growth potential even
after interest rates have been restored to their
proper level.
This also has implications
for asset returns. If multifactor productivity has
entered a lengthy period of sluggishness, with the
Bernanke years and the years of squeeze that must
follow, then traditional ideas about investment
returns must be sharply scaled back.
We
have already seen the beginnings of this in a
decade in which stock returns were below zero in
real terms, although the buoyancy of bond returns
and the rise in commodity prices have helped to
disguise this effect. Going forward, the sluggish
growth in multifactor productivity must inevitably
reduce the intrinsic value of common stocks,
prolonging the period of negative real returns for
a second and even possibly part of a third decade.
We have seen this before, in the stubborn
refusal of stock prices to exceed their 1929 highs
until as late as 1954. This time, there has
already been some nominal movement beyond the 2000
peak levels in the Dow Jones and Standard and
Poor's 500 stock indices, but the return of normal
real interest rates will inevitably squeeze out
this gain and collapse stock prices. It must be
remembered that the stock market in February 1995,
at the beginning of a lengthy boom, was at just
4,000 on the Dow index, equivalent to less than
8,000 today when inflated by nominal gross
domestic product.
Multifactor productivity
data are an enormously useful analytical tool;
they illustrate the fundamental growth in the
economy due to advances in technology, when labor
and capital changes are factored out. However, the
information they give us on the current state of
the US economy and markets confirms and even
darkens the pessimistic view.
Martin
Hutchinson is the author of Great
Conservatives (Academica Press, 2005) -
details can be found on the website
www.greatconservatives.com - and co-author with
Professor Kevin Dowd of Alchemists of Loss
(Wiley, 2010). Both are now available on
Amazon.com, Great Conservatives only in a
Kindle edition, Alchemists of Loss in both
Kindle and print editions.
(Republished
with permission from PrudentBear.com.
Copyright 2005-11 David W Tice &
Associates.)
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