(What’s Left of) Our Economy: So You Think Trade is an Engine of Productivity Growth?

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economics, economists, European Central Bank, exports, free trade, GDP, gross domestic product, imports, International Monetary Fund, labor productivity, productivity, productivity growth, total factor productivity, Trade, trade openness, World Bank, {What's Left of) Our Economy

The idea that the more international trade a country engages in, the more strongly its productivity will grow, is widely accepted among economists. Indeed, no less than the World Bank, the International Monetary Fund, and the European Central Bank (the eurozone’s version of America’s Federal Reserve) say so.

How then, can these august institutions and other believers explain the following: On the one hand according to the United Kingdom’s Royal Statistical Society, the country’s feeble annual average labor productivity growth of 0.3 percent over the last ten years was its “statistic of the decade”? Worse, it was the poorest decade for British productivity growth since the early 19^th century.

Yet on the other hand, during this period, the United Kingdom’s openness to foreign trade – a data point created by adding a country’s imports and exports and then expressing this sum as a percentage of its entire economy, or gross domestic product (GDP) – has for the most part been hovering near post-1960s highs. In other words, the more foreign trade the UK has been engaging in, the lower its productivity growth seems to have become.

Nor is this phenomenon restricted to the UK. The same pattern can be seen in the United States, although the country’s openness to trade is much lower than the United Kingdom’s in absolute terms (not surprising, since we’re comparing an island with a continental sized economy). RealityChek regulars shouldn’t have to be reminded about America’s discouraging collapse in labor productivity growth.

What about trade? In fairness, America’s openness to trade has been falling recently. But no, that’s not President Trump’s “fault.” The decline began in 2011, when trade’s share of GDP hit a post-1960 high of 30.79 percent. As of 2017 (the latest data year available according to this source), it still stood at 27.09 percent – much higher than the period average of 19.29 percent.   

Also in fairness: Simply because openness to trade for these two big national economies has coincided with lousy productivity growth doesn’t mean that openness to trade causes the problem (or vice versa). It doesn’t even mean that openness to trade is the main productivity culprit, for many different characteristics of an economy influence any single characteristic.

But certainly in light of the American and British experiences, even if the conventional wisdom is right and trade openness does encourage productivity growth, it’s clearly a policy choice that’s often overwhelmed by other features of that same economy. P.S. – it ain’t just the Anglo-Americans. The World Bank’s databases also portray global trade at only slightly off its all-time high as a share of the global economy. And guess what? It turns out that global productivity growth has been crappy lately, too, whether we’re talking labor productivity or total factor productivity (a broader gauge that measures output from the use of many different inputs, not just labor).

As a matter of fact, it’s not difficult to think of ways in which more trade can undermine productivity growth – e.g., if import floods decimate the sectors of the economy that have historically been its manufacturing leaders, or if trade policy fosters their offshoring. (Strong cases can be made for both propositions when it comes to American domestic manufacturing.) 

So the case that trade fosters productivity growth is hardly a slam dunk.  And that’s one more reason to believe that the broader case for free trade isn’t, either.

(What’s Left of) Our Economy: A Unproductive Study on Productivity and Pay

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Greg Ip, Larry Summers, manufacturing, productivity, productivity growth, secular stagnation, The Wall Street Journal, Trade, unions, wages, {What's Left of) Our Economy

One of the most important and heatedly debated trends affecting the economy is the nature of the relationship between what workers earn and how productive they are. Judging from a new Wall Street Journal summary of a new academic paper on the subject, the pay-productivity relationship is going to remain heatedly debated. In the process, the Journal report (the paper itself isn’t yet available on-line) indicates that in major respects, the study (co-authored by former Clinton Treasury Secretary and former top Obama economic adviser Larry Summers) may wind up making the subject more muddled than ever.

According to the Summers study (in the words of Wall Street Journal writer Greg Ip), the recent conventional wisdom about productivity since the 1970s rising much faster than pay is wrong. Instead, it found “a strong and persistent link between hourly productivity and a variety of wage measures since 1973.” And although the two sets of data have been diverging, Summers and his colleague claim that, “The problem…is that the positive influence of productivity on pay has been overwhelmed by other forces pushing the other way.”

That’s an entirely reasonable conclusion. After all, as I’ve frequently pointed, the idea that major trends and developments have only one or a small handful of causes is usually wrong. But I find the Summers case fishy for several reasons.

First, at least as Ip writes, the study’s authors don’t seem to be challenging the contention that productivity has been rising much faster than pay since 1973 at all. On a purely mathematical basis, they state that, during short periods, there’s been a consistent tendency for productivity to rise somewhat faster than pay, and that over the entire multi-decade period examined, the accumulation of these relatively modest gaps produced a large gap. That sounds like a distinction without a difference to me.

Second, Summers and colleague seem to assume that one of the productivity-enhancing forces at work in recent decades has been trade. But that belief seems pretty far-fetched given how trade policy in recent decades has pushed offshore so much American manufacturing – the economy’s productivity growth leader for the last three and one half decades – or turned the other cheek as foreign predatory practices have undercut domestic manufacturing production. Good luck to any economy thinking that it can neglect the decline of its most productive sector and maintain the pace of productivity growth.

Third, and conversely, Summers’ study assumes that forces other than trade (and technological advance) have been “eating away at the ability of workers to share fully in the rise in productivity.” The culprit they single out? “Weaker unions.”

Organized labor has undoubtedly been clobbered since 1973. But why don’t Summers and his co-author recognize that trade policy mistakes bear much of the blame? In particular, how likely are workers to bargain hard for higher wages if they realize that they can easily be replaced by a much cheaper (and equally productive) Mexican or Chinese counterpart? Moreover, wage pressure throughout the economy is bound to decrease as displaced manufacturing workers start competing for remaining services jobs.

One issue on which I do agree with Summers: the significant productivity growth slowdown that’s afflicted the economy in the post-1973 period, and especially since the last recession struck at the end of 2007, has dragged seriously on wage growth, and needs to be reversed. But unless the pay-productivity gap is closed as well, the only way for the political and business establishment to keep U.S. living standards at even minimally acceptable levels will be to keep injecting artificial stimulus into the economy, and boosting its already dangerous addiction to borrowing and spending bubbles.

In fact, there’s been a prominent economist who’s been arguing lately that that’s exactly the trap that the nation has been stuck for many years. He calls it “secular stagnation.” His name? Larry Summers.

(What’s Left of) Our Economy: Links Between Low U.S. Pay and Low U.S. Productivity Growth

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compensation, construction, finance, government, healthcare, manufacturing, productivity growth, restaurants, retail, services, {What's Left of) Our Economy

It’s long been clear to me that one big reason that Americans give lousy grades to the current economic recovery is that it’s been dominated by employment gains in lousy jobs. So it was great late last week to see strong confirmation provided by the Financial Times‘ Matthew Klein – who in the process showed that the problem has much deeper roots than my work has suggested. Klein also makes clear that this discouraging job creation pattern deserves much blame for lagging American productivity growth – which is crucial for the sustainable improvement in the nation’s living standards.

In a September 8 post, Klein demonstrated that since 2000, 94 percent of the net new jobs created by the U.S. economy came in education, healthcare, social assistance, bars, restaurants, and retail stores. When you weight these industries by their sizes, you find that their hourly pay has averaged 30 percent lower than in the rest of the economy – as per this chart he provides:

But the low-pay story hardly stops there. To add insult to injury, since jobs in retail, restaurants and bars typically involve shorter hours than in other sectors, weekly pay in these parts of the economy is fully 40 percent lower than in other industries. And these low-pay industries have been become such important American job creators that their relative growth has depressed the entire workforce’s weekly pay by three percent since 2000.

Further, in case you’re wondering, the employment trends have accelerated during the current recovery.

Even worse for the U.S. economy, especially over the longer term, the sectors producing all these lousy jobs have been sectors with big productivity problems. According to Klein, 96 percent of the net new jobs created in America since 1990 have come in industries known for low productivity (like construction, retail, and bars) or where low productivity is simply suspected, but understandably so, since they don’t feature much competition. (Healthcare, education, government, and finance fall into this category).

And of course, this evidence demonstrates the converse proposition, too – job creation has lagged during both these periods (and nosedived since 1990) in manufacturing, historically the economy’s productivity growth leader. And since it rebounded strongly after a recessionary crash dive, manufacturing output has stagnated at best.

As I’ve written, productivity is the subject economists generally regard as the most difficult to study, especially because it’s so hard to measure in services (which comprise most of the economy on a standstill basis), and especially when those services and their development are based on emerging technologies.

But one aspect of the productivity growth slump does seem to be rendered much less mysterious by Klein’s analysis: When an economy lets so much of its most productive sector stagnate at best, that’s sure not going to help its productivity.

(What’s Left of) Our Economy: Productivity Growth Now Stuck in Reverse

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labor productivity, manufacturing, multi-factor productivity, productivity, productivity growth, {What's Left of) Our Economy

Since America’s productivity growth has been terrible for several years, it’s surely big news that today’s Labor Department report on this measure of efficiency was almost historically terrible.

In its release on labor productivity (for the second quarter of this year), the department announced that the U.S. economy’s ability to turn out a unit of goods or services per hour worked fell sequentially for the third straight quarter. A performance that bad hasn’t been registered since 1979 – when under then-President Jimmy Carter, the nation was struggling with double-digit inflation and unemployment.

These results are preliminary, and therefore the final statistics could be better. But since American businesses keep on hiring at a relatively healthy clip (as revealed by last Friday’s jobs report), and the U.S. economy keeps growing slowly (as revealed in the latest gross domestic product report), a significant upward revision would be a major surprise.

It’s also possible that when we get second quarter data on multi-factor productivity, which gauges efficiency based on several inputs in addition to labor, the picture will look brighter. But these multi-factor numbers won’t be out until next year, since they take longer to calculate. And so far, they’ve been no better than the labor productivity data.

The new Labor Department report presents four sets of figures deserving attention. First came the actual second quarter results – which showed that non-farm business labor productivity dropped by 0.50 percent at an annual rate from first quarter levels, and that manufacturing’s performance (a subset of non-farm businesses) dipped by 0.20 percent.

Second came the revisions for the first quarter. The non-farm business figure stayed the same, at -0.60 percent annualized, but manufacturing saw its sequential labor productivity improvement upgraded from 1.30 percent at an annual rate to 1.50 percent.

Third, the government revised the last few years of annual productivity growth results, and, as with the first quarter manufacturing figure, these new overall numbers also came in a little better, while industry’s results were mixed:

Non-farm Business labor Productivity Growth    Old             New

2013                                                                     0.00%       +0.30%

2014                                                                   +0.80%      +0.80%

2015                                                                   +0.70%      +0.90%

Manufacturing Labor Productivity Growth         Old             New

2013                                                                  +0.70%       +0.20%

2014                                                                 +1.50%        +1.70%

2015                                                                 +0.20%        +0.30%

Finally, this morning’s productivity report permits a new comparison of the economy’s performance during the last few recoveries – the best way to measure trends over time. And here, the changes aren’t big, but they’re tilted to the downside – and the biggest negative revisions are in manufacturing:

Non-farm Business Labor Productivity Growth      Old           New

1990s recovery                                                     +23.01%    +23.01%

2000s recovery                                                     +16.08%    +16.07%

current recovery (through first quarter)                 +6.58%      +6.73%

Keep in mind, however, that the newest (second quarter) results drag the total improvement for this recovery down to 6.58 percent.

And now for the revisions to manufacturing labor productivity:

                                                                               Old              New

1990s recovery                                                  +49.96%      +46.65%

2000s recovery                                                  +41.09%      +41.07%

current recovery (through first quarter)            +24.85%       +22.82%

And the new second quarter results reduce the cumulative manufacturing improvement during the current recovery to 22.76 percent.

Some economists still believe that these official data are largely missing the productivity-boosting effects of new technologies, and they could still be right. But interestingly, I’m not seeing his objection nearly as much these days as in months and years past. A strong consensus seems to be consolidating that the U.S. economy – including its once productivity-leading manufacturing sector – in mired in a major productivity slowdown. There’s no consensus on how to fix the problem, but at least we seem to be moving past the denial stage.