productivity

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Two Definitions

Two definitions, one for ‘essential’ and the other for the way in which, according to economics, people are rewarded for their work.

In recent weeks we have become accustomed to calling someone an ‘essential worker’.  These are our most important people.  They are, if the dictionary doesn’t lie, indispensable.  They are extremely important.  They are key, crucial, vital, and needed.  They sound pretty darned special to me.  They must be doing things that, were they not doing them, would bring the economy to a screeching halt.

My goodness, they must be paid a lot.  Surely anyone who is a vital cog in the machinery is paid commensurately with that importance.

Not really.  Not at all for most of them — the exception here in the U.S. being doctors.  No, most of our ‘essential workers’ are amongst our least well paid.  They cannot afford to live in the cities or towns where they do their essential work, so they commute and thus expose themselves to the risk of contracting the virus that is our current scourge.  They certainly aren’t paid for that risk, no matter what the finance textbooks tell us about risk and reward.  Apparently only the ‘risk’ managed by hedge fund mangers and their ilk matters, even though it turns out they aren’t essential at all.  Instead they sit safely ensconced in their second or third homes, or on their yachts, moving paperwork from one side of the desk to the other, and getting paid very nicely for all that incredible effort.

Economists tells us that people are paid for what they produce ‘on the margin’.  Indeed, marginal productivity, as this particular piece of economic fiction is called, is fairly uncontroversial even among the so-called progressive economists. John Bates Clark describes for us the effect of this oddball idea:

“the distribution of the income of society is controlled by a natural law, and that this law, if it worked without friction, would give to every agent of production the amount of wealth which that agent creates”

It’s a natural law!  It sounds pretty sensible too: you get out what you put in.  Sort of.

And it seems to imply that economic theory is comfortable with our most essential workers not adding much to our collective wealth.  Whereas hedge fund managers on their yachts moving paperwork around do.

Which is upside down.  But that’s not unusual for economics, whose most ardent practitioners take a particular delight in being counter-intuitive.  So, whereas those of us poor souls who think words have regular meanings would think that essential workers are those who are adding the most value, economists and their more irregular meanings don’t think that at all.  Isn’t this counter-counter intuitive?  Are economists so befuddled by the elegance of their machinery that words have lost all meaning?

Marginal productivity only exists in order to establish a ‘natural law’ to frighten workers into believing that they have to settle for poor wages — who can overturn a natural law?  The fact that society sees some workers as essential doesn’t matter to economists.  What matters is preserving a variety of interlocking intellectual marvels so that their Ptolemaic apparatus doesn’t implode.  That this produces circumstances where essential seems to mean trivial rather than vital is not an issue.  The goal is to preserve the machinery, it is not to make sense.

So one of the bedrocks of economic theory says that our most important workers are doing something that adds little to no value.  They are essential but, well, not essential.  They are hugely important to the workings of the economy, but ought be poorly paid because of their insignificance.

Am I the only one to find this odd?  I must have missed something really counter-intuitive.

Maybe it’s the pandemic playing with by mind.

And, don’t get me started on ‘revealed preference’!  We can laugh at that another day.

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Same Old

Allow me to break my silence for a moment and comment on David Brook’s latest apology for the status quo. I realize others have already done so, but I feel compelled to add to the discussion.

First: by way of explanation for my absence. I have been busy elsewhere, and especially busy looking at the future of the workplace.

Second: it is because of this detour that I want to take a shot at Brooks.

Let’s recapitulate Brook’s argument. He takes a look at the last couple of years and extrapolates. He wants to debunk that argument that the American economy faces a crisis of distribution, and replace that problem with another: America has a productivity problem.

Why is this important?

Because has become a totem of both right and left sided populists that the economy is failing to generate opportunity, income, and security for the vast middle class. It has become commonplace for us to read about the decline and/or disappearance of that famous center of economic and social gravity. This is especially true in the aftermath of the Great Recession of 2008, and the subsequent glacial pace of recovery.

If it is true that the economy has been rigged in favor of a few — the much criticized 1% and big business — then populists of all stripes have a good case and the debate becomes one of how to divide the spoils of growth more equitably.

If, on the other hand, distribution is not the issue, but the problem is the deeper one of growth itself then the debate can be shifted by the likes of Brooks back onto their preferred territory.

Brooks goes to great lengths to describe our economic problem as being a lack of productivity growth. He tells us that the recent uptick of 1.1% is miserable in any decent historical context. And indeed it is. But to focus on recent years is to miss the larger and much more historically important point: the last four decades have seen a growing chasm open up between the pace of productivity growth and the pace of wage growth. A divergence has emerged that belies the traditional and orthodox view in economics that productivity growth inevitably filters down [or up?] into wage growth. As David Ruccio points out in his own critique of Brooks labor productivity has risen 76.1% since 1987, whereas wages have grown only 5.5%.

During this time the share of our national income going to wages has shrunk whilst the share going to capital returns has increased.

Of course these two trends are linked.

And this is my point:

The early 1980’s saw a sea change in corporate management technique. In particular various ideas that had been marginal throughout the post-war period suddenly emerged as central to modern management. Primary amongst these techniques was the idea of “shareholder value”. This is a doctrine based upon the same sandy foundation as mainstream economic theory, and it is no accident that the infamous Milton Friedman was a cheerleader for its adoption.

The main thrust of shareholder value is that a corporation must be managed to maximize returns to shareholders and that other goals are distractions.

This was, at the time, a revolutionary redirection of the purpose of management. Up to that point managers were regarded more as administration specialists and were presumed to take into account a wide range of targets for their efforts. They were not expected to narrow their focus so radically as to exclude all but shareholders from their concerns. Indeed the most successful books on management prior to 1980 scarcely mention shareholders at all. More to the point: very few, if any, companies have internal by-laws dictating that shareholder value is the aim of the business’s existence. Their is no legal injunction urging management on. It is all an ideological construction.

But, along with the radicalization of economics itself, the doctrine of shareholder value swept to victory in management suites across the country. It became necessary for management to pursue ever higher returns to capital even if this implied an obsession with short term investment and the sacrifice of a longer term perspective.

Inevitably business strategists trying to make a name for themselves developed an entire panoply of ideas that supported this quest for returns on capital. A key one being the notion of core competence, which simple though it sounds, led to a revolution in the workplace and whole litany of subsequent ills.

Managers compelled by the incessant urging of Wall Street to increase profits sued the idea of core competence to shed, first layers of middle management, second peripheral activities such as IT, and then to ship entire parts of their companies abroad in search of lower cost labor and thus higher returns on capital. So the 1990’s became a decade of downsizing, outsourcing, and offshoring, and we end up with sone of our largest companies in terms of sales being slivers of what their predecessors once were. Apple, as an example, tells us that “is responsible” for about 750,000 jobs, but only around 75,000 of those workers are employed directly on Apple’s books. The rest are scattered around the globe and are subject to work and wage conditions that Apple blithely ignores.

Along the way, also in order to bolster shareholder value, corporations did away with a whole slew of benefits, they altered their retirement plans from “defined benefits” to “defined contribution” and thus placed the burden of financial planning on the shoulders of their workers. They reduced or eliminated costly training programs and preferred, instead, to rely on workers taking on the responsibility to train themselves.

The list of corporate activities that were re-invented in the service of shareholder value is too long to do justice to here, but the malevolence of the consequences are easily seen in the divergence of the rewards going to wages as opposed to those going to capital. Most of this shift could not have taken place without the revolution in information processing that obviated the need for middle management, and allowed the development of worldwide logistical arrangements that bolstered productivity, but far from likewise bolstering wages actually inhibited wage increases.

So Brooks could not be more wrong.

Apart from the onrushing threat of automation, which is constantly sold by its apologists as a boon for productivity, the distribution of the manna produced by all that productivity is our number one economic issue. The data simply doesn’t support his contention otherwise.

One last thing: even were Brooks to have a good argument his solutions remain firmly in denial of reality. In order to shake up a moribund economy that is struggling to generate much growth he suggests all the usual right of center policies such as the reduction of regulation and so on. What he appears to miss, or is ignorant of, is that our economy has become steadily more subject to oligopolistic control. In almost every industry oligopoly stifles precisely the kind of entrepreneurial activity he advocates. Such is the dominance of our largest companies that they act to slow down innovation which they see, rightly, as a destabilizing threat to their longevity. When Brooks and his ilk start advocating the break-up of our biggest banks, or the empowerment of the anti-trust part of the SEC, we will know he takes his own ideas seriously.

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Productivity and Its Place In Our Story

The stock market is rising strongly today after yesterday’s plunge. I won’t bother to dignify this extraordinary oscillation with a comment other than to say that anyone who believes stock’s are “efficiently” priced has a lot of explaining to do. Precisely what, I wonder, is so positive today that it can offset yesterday’s negativity. More to the point, how come that positive news was unknown a mere 24 hours earlier? But as I said I won’t ask those questions.

What we can do, however, is to take a short break from bemoaning the absence of leadership in economic policy to reflect on yet another poor number: productivity seems to have tanked recently.

This morning’s data are far from rosy: productivity declined 0.3% in second quarter, while it was revised to a decline of 0.6% in the first quarter from what had originally been reported as a 1.8% gain. This is not good. This makes two successive quarters of decline which we hadn’t seen since 2008. Moreover, productivity has crawled up a mere 0.8% over the past twelve months, which is another bad performance and a sign of things being out of kilter deep within the economy.

The irony is that the weakness in productivity is coming from rising unit labor costs. Before you all fall off your chairs, let me remind you that unit labor costs are not simply a reflection of wages, but are, as they sound, a measure of the cost per unit of output – a ton of steel for instance. So if the labor effort rises more rapidly than output, productivity falls. In the longer term this cramps the space available for profit and wages, which is why we pay attention to productivity in the first place. But it is also something that is devilishly difficult to calculate, especially in service industries. Exactly how do we measure the unit cost of a legal brief? And what, exactly, is the output of a legal brief? Stop chortling, these are important things to consider, especially in an economy like ours which is heavily skewed towards service industries.

What appears to be going on at the moment, by which I mean the last six months, is that output has not risen as fast as the effort going in. And the cost of the effort going in is not a function of rising wages as much as it is a reflection of the extra hours being worked. In fact real wages – wages adjusted for inflation – are falling, by as much as 2.1% last quarter.

The problem with untangling the story from the numbers is that we can give two equally plausible accounts, but which contradict each other in a more general context.

First: productivity could be falling because businesses misjudged demand and over-hired relative to what they ended up needing to produce. According to this view we should expect that companies retrench and trim hiring to get back into a better, more profitable, balance. Or, second, businesses may have misjudged an increase in demand and have had to hire workers at a greater rate, implying that future productivity reports will reflect a better balance at a higher level of activity – the adjustment needed for those new workers to produce at an efficient level being the ongoing factor distorting productivity currently. This more positive view suggests we should see more hiring as businesses calibrate activity against unexpectedly large demand.

Naturally we need to look at other statistics in order to select which of these two narratives is the more likely explanation, and, unfortunately, I suspect we are led to choose the negative over the positive.

Why?

Because it fits well with our overall narrative that the economy has approached a stall velocity and that demand is weaker than many people – although not us – expected. As we slog through this part of the annual planning cycle in business we can surmise that the outlook for 2012 against which businesses will array resources is less hopeful than it was a year ago. This will exert caution. Budgets will be restrained, if not cut. New hiring will postponed as current staffing levels are re-assessed. And, in general, activity will be based against lower expectations.

Any economy wading its way through a major balance sheet adjustment, as ours is, will grow both fitfully and slowly. There will be many episodes of reappraisal as both households and business cast wary glances at each other. Households fear unemployment and face the risk generated by not being able to support debt loads. So they look for ways to trim expenses and pay off debt, rather than spend. Extra income is channeled towards debt reduction and does nothing to boost demand. This is a major factor why tax cuts have little stimulative impact: people save them. This attitude on the part of households causes business to predict weak demand, and so annual budgets reflect weak hiring and investment requirements. It may well be that, as is the case now, businesses are flush with cash. But they see no profitable investment opportunity other than to save labor costs by replacing labor with machinery. Cost cutting becomes even more a vogue in these circumstances and so households, in turn, worry even more. And so it goes.

Within this negative cycle there can often be moments of what appear to be recovery. Households and business both need to replace worn out things so not all spending can be postponed forever. Thus, even in a debt crippled economy, there can be quarters of growing demand. But that growth quickly dissipates as the longer term retrenching trend re-asserts itself.

It is this search for a solid footing with respect to debt levels that is dominating our economy. Our private sector is disgorging debt. It can do that through default which is the process we are still seeing in housing. Or it can take the much slower route and pay down debt from income, which is a trend we are seeing in aspects of consumer credit. This latter process is particularly difficult at the moment because incomes are not rising quickly, if at all, and inflation is very low, so the inflation burden of debt remains high. Getting average earnings to rise, or allowing a bout of inflation would both accelerate our recovery. Unfortunately neither looks likely.

Those of us who look at the economy through the prism of debt and balance sheet adjustment are not at all surprised by the recent string of bad news. It was always the more likely outcome. Policy has not been anywhere near sufficient to deal with the root causes of the crisis: not in terms of stimulus; not in terms of debt relief; not in terms of bank reform; and not in terms of enforced loss recognition. Policy makers seem to have viewed this recession/depression as yet another typical post-war recession. This was a gargantuan error. The accumulation of mistaken policy decisions, up to and including the US austerity effort, is making it harder to conclude the adjustment process. So we are faced with years of unnecessary malaise and uncertainty.

This narrative is a long way from the productivity report I began with, but, hopefully, you can see that, when viewed through the lens I have described, nothing in that report, or any of the other recent reports should be a surprise.

Expect more like them.

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Where Are We?

It’s tough to tell exactly how the recovery is going. Since this is a busy week for data reports it behooves us to step back and set the stage.

If you recall, at the end of last year the economy was growing at around 3.0% to 3.5% at annual rates. That was a marked improvement, but not earth shattering in the context of post-war recoveries. The general opinion was that we would pick up speed into the first quarter before settling down into a post-recovery ‘normal’ period of steady growth. I was always a slight dissenter to this view because I put more emphasis on our lingering unemployment problems, the risk still abundant in banking, and the downward weight resulting from the real estate collapse. Plus the fourth quarter had one or two oddities – trade and inventories – that pulled reported growth from its underlying trajectory. So my view was that growth would stick in that 3.0% range and then fall a little as we went through this year.

It looks as if we were all wrong.

The problem with the first quarter, we sill see the initial estimate this week, is that the string of oddities has continued. This time things like the very bad weather have taken their toll, and so we should all expect a much lower growth rate than originally thought. If we use the so-called Blue Chip consensus as our guide, the original commonly accepted growth rate was somewhere near 4.0%. This was based on the idea that the recovery was still accelerating, and had not yet peaked, and that consumer demand was bouncing nicely away from the depths plumbed in the recession.

Now that same consensus is looking for a first quarter of 1.7%, with the dramatic revision due to the weather and the fact that consumers have turned much more pessimistic again.

Apparently, one bad winter, and a sudden spike in oil and food prices, have done the recovery in.

So much for robust.

This, in a roundabout way, supports my view, although I make no claim for prescience. The issue is straightforward: as long as unemployment is high, and as long as home prices are weak, households will not shake off their sense of siege completely. It won’t take much to set them back into a savings mode. Likewise, banks may be reporting solid profits – or at least some of them are – but much of the improvement is coming from changes in loss rates, and trading rather form the basic banking that engages with the real economy. This is why I still think we are in a long haul and slow recovery, rather than in the middle stages of a typical post-war bounce back.

Add in the short term rise in consumer inflation caused by those food and oil price increases, and the mood has changed quickly.

This morning’s data on real estate is illustrative.

Sales of new homes in March climbed well: up 11% from February. On its face this is solid. But February was especially depresses because of that bad weather, so a large share of the rebound is simply the working off of a mild backlog. The average between the two months gives us a better longer term measure of sales, and that is essentially flat. Couple this with the news that builder expectations are still at incredibly low levels, and that the inventory of unsold new homes, at 183,000, is stuck somewhere around its 1967 levels – i.e. at near all time lows – and any image of recovery pales away to be replaced by one of decidedly abnormal and low activity. Certainly nothing in real estate suggests a return to good growth. Right now moderate growth would suffice.

The reason I am belaboring this is that when GDP for the first quarter is announced we will all be trying to divine its import for the rest of the year. I am arguing that it may not be much of a signpost at all. It may be too riddled with quirks. That implies we are better served looking at the more frequently announced numbers to get an idea of the general health of the economy.

And those numbers support a very modest outlook.

So what are the risks or problems that prevent us from moving along at a great clip?

  1. The absolute size of the hole we dug back in 2008/2009. This was one mother of a recession, and it has left immense slack throughout the economy. Until that slack is picked up there is little to no incentive for businesses to invest. This is despite interest rates being at ludicrously low levels. Some analysts argue that the Fed’s loose monetary policy has had no discernible effect on investment and thus is a failure. I disagree. It wasn’t a bust. It wasn’t a roaring success either. It just was. It is tough to critique the Fed when the entire system was so close to crumbling. Let’s all remember: the private sector vanished in very short order. Were it not for the government we would have vanished along with it. Business is rightly cagey when faced with skittish consumers and goods of spare capacity. So we can take robust investment off the table as a driver of near term growth.
  2. Austerity budgets will cause at least short term pain. They probably will cause long term pain as well, but that’s not our issue here. Luckily for us the debate will ramble of for a while, so the impact of less government spending will not be hugely significant this year. But it will be a real and noticeable drag when it does show up.
  3. Unemployment is still way too high. Yes, the trends have improved, but by any standard we are a very long way from a return to normal. The labor markets are very fragile. I expect them to stay this way for many more quarters.
  4. World imbalances will leak over into the US economy. Particularly in the form of a continued run up in some consumer prices. There is an argument to make that the world economy is headed into a period of generally higher prices due to the rapid growth of emerging economies and the stress that puts on supply of raw materials and food. But the recent spike in prices is not necessarily indicative of where that longer term price level will be. Short term supply constraints and like the turmoil in the Middle East, and rotten harvests, are masking the long term trend. I expect prices to settle back down, rather than to escalate wildly out of control. Nonetheless in the near term this spike has illustrated jut how vulnerable consumers are.
  5. That is the lesson we need to absorb. Confidence is fragile. To the extent that we rely on consumption and a return to healthy levels of sustainable demand, we are a long way from cured. This past few months have taught us, vividly, that consumers are acting as if on a knife edge. They are pessimistic one day, then optimistic, and then back in the doldrums. The battering they have taken has numbed them sufficiently that they will take a great deal of persuasion before they declare the recovery complete enough to spend the way they once did.
  6. Banking is not yet safe. Since we didn’t reform the banks to make them less dangerous, we have to assume that they are busily constructing their next disaster. Which we, inevitably, will be expected to pay for. Like all habitual blackmailers, the banks will not reform of their own accord. They need to be forced to behave. We will not achieve long term sustainable growth whilst banks are more interested in gambling than in underwriting loans that support the real economy. This shouldn’t be hard to understand, But apparently it is.
  7. Imbalances within the economy lower its potential trajectory. This is a longer term effect and perhaps out of place here, but I would be remiss for not mentioning that our enormously divided economy, between the haves and the have nots, is in itself acting as a brake on growth. It is my view that when the middle class is deprived of disposable income over long periods it cannot act as the economy’s primary consumption engine. It is no secret that the American economy is now so split with respect to the fruits of productivity, and thus income allocation, that its the middle class is now no longer capable of driving spending with sufficient force to justify investment. This sets in motion a steady spiral downwards. As investment is restricted, so future income growth is impaired. This encourages short term thinking in business in the form of cost cutting and wage freezes in order to maintain profit growth. The net result being a shift in income allocation away from wages towards profits and the steady throttling back of potential growth. If this view is correct, then the very clear bias in favor of profits as opposed to wage growth that has dominated American business for the past three decades will end up reducing long term profit. The greed of shareholders will ultimately be self-defeating as they stifle the middle class and thus the very source of their profit.

This is not an exhaustive list, but one point I want to make quite clear: I don’t think that the Federal deficit or the near term bulge in US debt is a particular problem. Our response maybe. Meanwhile we have left unaddressed many of the more obvious sources of risk, like the ones listed above. So as long as were are exposed to such a list we should expect a bumpy and not very fast growth pattern. There’s just too much out there lurking to derail us, and too little policy focus on a long term strategy to reduce inequality, for us to be upbeat.

So look for a lot of sideways motion.

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Productivity Grows. So What?

Sometimes it takes a very long time for reality to clash with long held beliefs. No amount of discordant information can shake some people from the bits and pieces of “truth” that they carry around with them. This seems to afflict economists more than most. Those dictums based upon orthodox theory die hard no matter what amount of contradictory data piles up.

A case in point:

“Increased productivity is critical to a rising standard of living because it usually leads to higher wages for workers and bigger profits for companies. When workers produce more in the same amount of time, companies can increase their pay and still make the same amount of profit or higher.”

This is a quote from MarketWatch, a Wall Street Journal online service. The article from which I took it is reporting today’s news that fourth quarter productivity in the US economy rose 2.6% – output rose 4.0%, while hours worked rose only 1.4%.

In textbook terms the quote is accurate. Productivity improvements through time are the great engine of wealth creation. Indeed wages and profits depend on productivity enhancement in order to sustain their growth.

But it defies belief that the reporter failed to note that the vast majority of productivity improvement in recent years, indeed decades, has gone towards profit and not wages.

I realize the quote includes all sorts of subtle hedges in its wording. The word “can” as in “…can increase their pay …” gets business off the hook. It means that pay increases do not necessarily flow from more productivity. They might. They might not. Companies might just decide that all the gain should go to capital. In which case the link between rising productivity and wages is broken. As it has been for years. In fact, in my opinion, that severance of the link between productivity and wage growth is one of the most significant stories of the last few decades. I have said it many times here: corporate profits have boomed while wages have stagnated. Understanding that separation is essential to understanding recent economic history. Looking back at the Bush era, the only major aspect of success in the economy was corporate profit. Everything else was decidedly average or worse.

That we can still use the old dictum as an off the shelf comment in a story about productivity is beyond me. It remains a true statement. But it has no relevance to today. It has no relevance to the economic situation faced by our workers. It displays an indifference to their plight and an ignorance of how demand plays into growth. It is also symptomatic of the failure of our economic and financial media to come to grips with the actual substance of the economy. They prefer to deal with orthodox abstractions as if they represent insights into real economics. Presumably that’s what they learned. Which is why they fail to see what is going on.

So much of our malaise rests on the extraordinary shift in wealth within the economy. As David Ruccio has shown us with all his charts and graphs, more and more of it is accumulated by fewer and fewer people. A major contributory factor to this rising inequality is the ongoing asymmetrical distribution of the spoils of productivity growth. Avoiding a discussion, or even a passing reference to this very evident fact, dilutes to meaningless the upbeat message the reporter is trying to get across. This may suit the readers of the Wall Street Journal, but it isn’t good reporting of the economy.

Further: one of the reasons that austerity budgets are so repugnant to average people stems from the failure of our economy to distribute the gains accumulated over the last three decades more fairly. They never gained in the good times, and yet they are being asked to pay the price in the bad times. The gradual suffocation of the middle and working class is very much a function of the failure of productivity improvements, much of which stems from extra hours worked, to flow to those workers as it used to. The Reaganite reversal of the post war social bargain that productivity gains were shared needs to be kept in the public eye constantly. The fracture of that bargain explains the trajectory we have followed. By reducing collective action, or common purpose, and replacing it with a relentless pursuit of individualism, we have turned long held relationships into historic artifacts. They are quaint. They are not useful today. Looking at the recent data we do not live in an economy where productivity and wages are linked.

So we need to toss the idea overboard. That might be true in theory. Though I doubt it ever was as closely related as the orthodox think. Why? Because their theories eliminate collectives. Except for the great collective known as the market. But that’s another story.

Back in the here and now we need to explain why it is that businesses can see significant gains in productivity and yet not increase wages. And don’t tell me that it is a function of slack in the workforce because of the crisis. That doesn’t explain three entire decades.

The quote I began with demonstrates an ignorance of the real story. Or a willfulness in ignoring it. The headlines should be: “productivity rises but wages flat“.

Now that’s a story worth being told.

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