29 June 2015
Stephen Roach, former chief economist of Morgan Stanley, has been puzzled by what he calls the "productivity paradox". "Over the past five years," he notes,"from 2010 to 2014, annual US productivity growth has fallen to an average of 0.9%. It actually fell at a 2.6% annual rate in the two most recent quarters (in late 2014 and early 2015). Barring a major data revision, America's productivity renaissance seems to have run into serious trouble."
The graph of Year-on-Year growth of Nonfarm Business Sector: Real Output Per Hour of All Persons illustrates what he says.
But if you look at the right parameters there is no puzzle or paradox. The numbers are perfectly logical as we shall now see.
As economics textbooks never tire of telling you, a worker with a backhoe can dig more mud than a worker with a shovel. The backhoe of course costs much more than a shovel, which is to say that if you want productivity you need to make capital investments. And capital investment is exactly what has been lacking in the US economy since 2007, as the graph of real net private investment to real GDP shows.
If you consider an investment of 5% of GDP the minimum required to get the economy chugging properly, then the shortfall in investment since 2007 amounts to a total of 17.5%.
When unemployment is high and the labour participation rate low, low investment does not matter so much, because there is enough capital per worker to go around. Consider, for example, a factory with 10 employees and 10 CNC lathes. When the recession began the factory let one worker go. So it could cannibalise one lathe to provide spare parts for the other nine. Or it could use two lathes to provide spare parts for the other and run the eight lathes for nine shifts a week instead of eight.
But as workers are rehired this leeway vanishes. Meanwhile, the machines that have been flogged cry for maintenance or replacement. Naturally productivity per worker falls. The fall in productivity is actually a sign that the economy is returning to normal.
Roach quotes Robert Solow's comment in 1987 that "you can see the computer age everywhere except in the productivity statistics." He then goes on to add: "The productivity paradox seemed to be resolved in the 1990s, when America experienced a spectacular productivity renaissance. Average annual productivity growth in the country's nonfarm business sector accelerated to 2.5% from 1991 to 2007, from the 1.5% trend in the preceding 15 years. The benefits of the Internet Age had finally materialized. Concern about the paradox all but vanished."
But when you look at the graph of real net private investment to real GDP you realize that the high productivity simply reflected investment that ran above the normal rate for a long time.
24 June 2015
The history of the US since 2001 is beautifully captured by the graph below. Personal Disposable Income fell after the crash but personal consumption expenditures fell even more. And seven years later the gap is not narrowing. The reason is that a large part of the US population lost years of accumulated saving in the crash and has raised its saving rate to recoup that loss. (According to the Fed's Survey of Consumer Finances 2010, the median US household's net worth fell that year to levels last seen in 1992).
Atif Mian and Amir Sufi in their book, House of Debt, ascribed the gap to households paying down debt contracted during the boom years. But as the graph below shows, the ratio of household debt service payments to disposable personal income is at its lowest level in 35 years. And still personal consumption expenditures have not recovered. So debt is clearly only part of the story.
My new ebook Macroeconomics Redefined has the full story.
P.S. The difference between the saving rates now and before the recession is about 3%. Household consumption accounts for about 70% of US GDP. Multiplying the two we get 2.1%, which is roughly the size of the gap between actual and potential GDP as per Congressional Budget Office estimates
20 June 2015
Proponents and opponents of austerity in the economics blogosphere have been hurling recriminations at each other in recent weeks.
Now one of the theoretical arguments in favour of government spending is what is called the "Keynesian multiplier" which shows that a dollar spent by the government results in total spending which is several times higher.
Assume that the government hires unemployed resources to build a $1,000 woodshed. The carpenters and lumber producers get an extra $1,000 in income. If they all have a marginal propensity to consume (MPC) of 2/3, they will spend $666.67 on new consumption goods. The producers of these goods will now have extra incomes of $666.67. If their MPC is also 2/3 they in turn will spend $444.44. The process will go on with each round of spending being 2/3 of the previous round. Thus a chain of secondary consumption spending is set in motion. But although it is an endless chain, the spending adds up to a finite sum. Mathematically, it is equal to 1/(1-MPC) or 3. Thus the $1,000 results in spending of $3,000.
In the US the saving rate is about 5%, so the MPC by this argument ought to be 20. In reality some of the money spent by the government will later be spent on imported goods and some will be taken back by the government in taxes. Even then the multiplier should be about 15. However, even the most optimistic calculated values of the multiplier are not usually more than 1.5. Why should this be so? Why does government spending have so little effect on the GDP?
The reason is that there is a fundamental flaw in the Keynesian multiplier argument. It confuses the average propensity to consume with the marginal propensity to consume.
In the figure below which shows the saving rate from 1990 to 2015 it will be seen that during each of the recessions the saving rate goes up and stays elevated for several years thereafter. During a recession, by definition, income is falling. A higher saving rate during a recession means that consumption is falling even faster than income. Since both are negative but the fall in consumption is greater than the fall in income, the marginal propensity to consume is greater than 1. Therefore the Keynesian multiplier which is 1/(1-MPC) is negative.
In physical terms this means that when the government spends an additional $1,000 consumers save more than $1,000. After the recession the multiplier moves closer to zero and then into positive territory. But this probably takes several years by which time the justification for government spending is over.
The above is adapted from my new ebook Macroeconomics Redefined
15 May 2015
The YoY growth rate of Corrected Money Supply (CMS) continues to fall, though the rate has moderated somewhat. In December 2014 the rate of growth had plunged to 8.4% from 20.2% in February 2014. In the three months since then it has only fallen to 7.3% at the beginning of March. In absolute terms, Corrected Money Supply is higher than in December 2014.
Since the last time we put up this graph, the US economy seems to have deteriorated somewhat. Could this be related to the monetary contraction? Probably, but we do not anticipate anything catastrophic for about a year. A Fed rate hike could of course change matters.
08 February 2015
The stock markets are near all-time highs, unemployment is falling steadily, the GDP is growing at a nice clip. Who would guess amidst such excellent signals that the US is going through a monetary contraction? But that is exactly what the graph below shows.
The YoY growth rate of Corrected Money Supply (CMS) has fallen from 20.2% in February 2014 to 8.4% in December 2014. By the end of 2015 the growth rate will be firmly in negative territory if it continues to fall at the current rate. And that is when nasty things can be expected to happen. The Fed could of course accelerate matters if it decides to raise interest rates.
Overall the economy is following roughly the same trajectory as before the 2008 crash. This time I suspect the end will be much nastier.