Do We Know Where Growth Comes From?

Teaching long-run growth in Principles of Macro can be a little difficult. After all, in the macro data, most growth in developed countries seems to come from “technological progress” and technological progress is measured as a residual. That is, we look at how much GDP grew, estimate how much was due to more capital, how much was due to more workers (or hours), and then see what’s left. That’s technological progress, or productivity growth.

So I agree with Nick Bunker that we don’t necessarily know where productivity growth comes from and why it appears to have slowed down recently. On the other hand, as Noah Smith points out, we know exactly where productivity growth comes from. As I tell my students, there are really only two sources of productivity growth: new products and services, and producing old products and services with fewer inputs.

When we’re chugging along, producing the same products and services with the same production technology, there is no productivity growth. There may be economic growth as we produce more, adding workers and capital in order to do so, but in order to have productivity growth, or technological progress, we need something new. One possibility is that we come up with new products: smart phones! electric cars! smart watches! This growth is actually fairly hard to measure as we need to compare something new that didn’t exist before to the old products. If both old and new survive, usually because the new one offers a different value proposition, this isn’t too hard. But if the new product or service kills off the old because it is better and cheaper (and therefore offers a superior value proposition), the growth could actually look negative at first. This is the argument that a lot of internet services have improved growth but simply aren’t showing up in the numbers. Not only are Google and Wikipedia free, but Encyclopedia Britannica is basically dead.

The other source of productivity growth is more straightforward to measure and involves producing the same products or services but with fewer (labor) inputs. This is what Noah focuses on in his post. The short-term fear has always been that as firms substitute new capital (and new technology) for labor that there is a disruption in the labor market and people lose their jobs. There has been an increasing amount of worry in this area as artificial intelligence could make a large number of jobs obsolete. But as Noah points out, so far technological progress has had a positive long-run effect for workers by making them more productive and pushing up their real income. It also often requires an increased investment in human capital which also pushes up wages. I think this is likely to continue in the future even if robots are doing most of the jobs that humans are currently doing. Humans will then find other things to do that either robots can’t do or that people don’t want robots to do. What are those things? I have no idea But 200 years ago most economists couldn’t have predicted all the 21st century jobs that didn’t yet exist either.

So from the micro side we know exactly where productivity growth comes from while on the macro side it remains a bit of an enigma and basically impossible to measure directly. The question that Noah asks in his piece of whether or not higher labor costs will lead to more productivity growth is an interesting one. A related question is whether higher aggregate demand will lead to more productivity growth. If so, that’s a possible argument for both a higher minimum wage and for reducing income inequality as there is evidence that the poor and middle class have a higher marginal propensity to consume that the rich. I have a paper that makes that argument, but it is not yet ready for prime time.

Paul, Hillary, and Bernie (and Unicorns!)

So once again, Paul Krugman is battering Hillary Clinton’s opposition. It really feels like 2008 all over again. Apparently Bernie Sanders believes in magical unicorns and will be even less effective in office than Hillary would be, never mind that if both face a Republican Congress than neither one is going to get anything done. My own opinion is that a recession is likely at the beginning of the next President’s term and that may end up dooming whoever is in the Oval Office to one term.

But I’d like to talk about what I think is going on in the Democratic primaries right now and why I’m not totally satisfied with either candidate. Clinton, like her husband before her, clearly represents what has become the middle of the road politically. That means while she supports a social safety net, she also doesn’t seem overly convinced that inequality is a problem, doesn’t see finance as a big problem, and does not believe that much can be done in the way of single payer health plan.

Bernie, on the other hand, is totally on board with most progressive policies, but may be more of a liability in the general election, is older than anyone else we have ever elected, and may be presenting economic analyses that don’t make sense (more on that in a bit). There is also the real question of which candidate could accomplish more in four or eight years with a likely Republican House and potential Republican Senate. Sanders has spent more time in the Senate than Clinton, but she may be more willing to compromise.

The big problem with Clinton, in my mind, is that she appears untrustworthy when it comes to finance, one of the key drivers of both inequality and instability in the economy. Giving speeches for (almost) three times my annual salary, becoming a wealthy person from a key industry that needs more rather than less regulation, is very worrisome. Sanders appears to be much more likely to take a firm stand against financial and other corporate interests. What he could do from the executive branch would be somewhat limited, but the DoJ and FTC could certainly use existing laws to help increase competition and reduce rents.

And then there is healthcare. While I agree with Sanders that a single payer plan is preferable and likely to be significantly cheaper in the long run, I also agree with Krugman that a single payer plan is unlikely to be in our near term future. But one of the questions that has arisen is about the cost of health care and the potential savings of moving to a single payer plan. Bernie’s campaign has made one set of claims while many health policy wonks have made another.

It is worth while in this discussion to ask why we in the United States pay so much for health care. Are we paying more per unit? Buying more units? Or flushing it down the drain? It seems like the answer is some combination of the three. Certainly the administrative and marketing costs of health insurance companies basically result in flushing a certain portion of every health care dollar down the drain. So moving to a single payer plan would save a lot of that expense. We seem to buy a bit more units of health care than in other advanced economies, especially at the end of life, but get very little for it. A single payer plan would likely limit that spending (at least what would be covered by the public plan) and so there would be some savings there.

But the biggest problem appears to be that we spend more per unit. The two big pieces of which are that we pay more for prescription drugs and we pay our doctors more. The question is then whether a single payer plan would help reduce these costs to a level similar to those seen in other developed countries with universal coverage. And the answer, I’m afraid, is that I don’t know. As Paul Krugman says in his textbook and as I tell my students to chant to themselves every night as they are falling asleep, “One Person’s Spending Is Another Person’s Income.” What that means is that if we want to spend less on health care, like other countries do, then some people are going to earn less. Health insurance companies will be out of business. Pharmaceutical companies will see profits fall. And doctors will see their paychecks shrink significantly. Do we have the political will to do that? I don’t know.

So who is the best candidate to lead us to the Progressive Promised Land? It’s hard not to feel like it’s Elizabeth Warren. But she’s not running. I think it’s likely that Bernie and Hillary get the same amount accomplished on the progressive agenda over the next four years: not much.

What is a “Good job” anyway?

The current debate about how to help the poor has focused on the desirability (or not) of increasing the minimum wage to $10.10, up from the current level of $7.25. Research seems to be split about the effect this would have on jobs, although the best research seems to say that it would most likely not reduce low-wage employment or employment growth and would lift a fair number of people out of poverty.

The typical economist response about how to help the poor, which I share for the most part, is to provide a strong economy in which good jobs are available and provide people with the skills needed to work in those jobs (or at least be able to be trained for those jobs). The second part means providing quality public education in which everybody becomes a strong reader and mathematically literate. These days it also probably means making sure everybody is comfortable with computer technology in all of its forms.

But what about the first part? Traditional macroeconomic management with the goal of full employment and moderate inflation is the first step (we obviously haven’t quite figured that out yet), but the second step is to think about what constitutes a good job. I believe that any job can be a good job. That is, people can enjoy, be productive in, and provide for themselves and their families, whether they are working as a farmer, an assembly line worker, a teacher, a doctor, a janitor, or even in retail service. That said, each and every one of those jobs can be bad jobs as well. So what makes a job good instead of bad? I think there are four main factors:

  • Pay. Let’s face it, pay is one way we measure our productivity. Not only can are we more financially secure the more money we make, but we also feel more valuable, both to our families and to society. There’s a big difference between working full time and making $15,000 (about the current minimum wage) and making $25,000.
  • Security. Economic activity is fairly volatile, and feeling that you may not have your job next week can make people feel just as unhappy and insecure as worrying about whether or not it will rain enough to grow the crops you need to feel yourself and your family. That said, I believe most workers understand that they will likely change jobs a number of times throughout their working lives. The question, then, is how easy or difficult this process becomes.
  • Control. Being a professor comes with one of the highest levels of job satisfaction. A (small) part of it may be pay. A significant part of it is likely the security of tenure (I wouldn’t know), but a large part of job satisfaction for academics also comes from control. Professors are generally free to design the courses they teach, choose the method of instruction, and choose the topics of research that interest them. This allows for much more control than most workers have.
  •  Value. Pay is one way to measure the value of what you do, but it is by no means the only way. People choose many jobs, teaching, police officers and fire fighters, social workers, etc. not because they get paid a lot, but because they feel they are doing something valuable. The more a worker feels that she is doing something worthwhile, the happier that worker will be.

Let’s think about what I didn’t include. While safety is important, I don’t believe it’s absolutely necessary for a job to be considered a good job. I don’t believe there is a particular type of work that is better than any other. When workers left the farms to join the factories, these were considered harsh, unnatural jobs. Now factory jobs in manufacturing are often considered one of the best blue collar jobs around. It is low wage service jobs that now come under fire, whether it is housekeeping in a hotel, working at a fast food restaurant, or selling clothes at the Gap. 

While there will always be some jobs that will be more desirable than others, do to extremes along one of the four dimensions noted above, history suggests that it is possible to improve most, if not all jobs, along these dimensions. 

Recently, I’ve been focused on bargaining power and the ability of firms (or workers) to move economic profits in their direction. A large employer, especially of less-skilled labor, is generally in a stronger bargaining position than its workers. This can lead the executives and managers in charge of firms, in an effort to reduce labor costs and increase productivity, to reduce pay, reduce job security, and weaken worker control. In the 1950s and 1960s in this country, and in many western European countries presently, unions have been able to exert a counterweight in order to fight back against this reduction in job quality. In the U.S., other methods such as employee ownership and open-book management techniques have also increased job quality by increasing potential pay, increasing workers’ control over their work environment, providing more job and financial security, and educating workers on the value of what they are doing. Other companies, such as Costco, focus more on pay and security, and have been quite successful.

Imagine the worst job you can. For me, it would be a minimum wage job in retail. Now imagine that the worker is empowered to make suggestions about how the work can be done, that the worker understands how his effort contributes to the companies bottom line, and that the worker stands to benefit when that bottom line improves. The actual work may be the same and may not be too enjoyable, but from the perspective of the worker, much has changed. Now when they come to work they are playing the game of business and have a stake in the outcome if they are able to win. And to me, that has to be a better job.

 

 

What is capital anyway?

Karl Smith and Matt Yglesias break down a graph from Thomas Piketty’s new book Capital in the 21st Century (published in French, but available in English next month). The graph shows the value of French capital as a percent of its GDP and shows that it fell in the middle of the 20th century and has increased in the last 40 years.

Or does it? Both Smith and Yglesias point out that what the graph truly shows is the changing nature of capital in the French economy. What we traditionally think of as capital (factories, stores, machines, etc.) has been fairly constant, at between 150-200% of GDP. But the value of agricultural land has fallen from almost 500% of GDP in 1700 to a negligible amount now (despite and because of the amazing increases in agricultural productivity). What has replaced it has been the value of French housing, which we can think of as the value of land, probably mostly in and around Paris. Eyeballing the numbers, it looks like it has increased from less than 100% of GDP to almost 400% of GDP.

So let’s think about housing for a minute. On the one hand, housing is clearly capital. It is a structure that provides housing services to whoever is living there. If it is not owner occupied then it provides a stream of income to its owner, just like other forms of capital. There is little difference, economically, between an 18th century rentier who owns large tracts of agricultural land and receives the rent coming from the product of the land and a 21st century rentier who owns many apartment buildings and receives the rent from the housing services they provide.

But what of the owner occupied housing that makes up most of the housing capital stock in the U.S. (I’m not sure about France)? It is clearly capital, in that it provides housing services and is an asset owned by the homeowner, but it is not clearly increasing the level of income inequality in the same way that agricultural land and other capital does. That is, capital in general will only increase income inequality as much as that capital in unequally owned. That was the case with agricultural land and is almost always the case with traditional capital as well.

But housing ownership in many developed countries has, I believe, been more equally distributed. And because owner-occupied does not directly provide income to its owner, it does not directly increase income inequality. To try to be a little clearer, imagine a world in which owner-occupied housing was the only capital in the economy. Housing and the land on which its sits, depending on its location, size, and desirability, would have different values. People with higher incomes would then purchase the housing that they liked the most and that fit within their budget. But the fact that someone who earned a million dollars a year might be able to purchase a Newport mansion while someone earning $30,000 a year had to make due with a two bedroom ranch would not further exacerbate the level of income inequality.

As my French has steadily gotten worse over the last 15 years, I’m waiting for the English version of Piketty’s book. But based on the reviews I’ve read, it certainly seems possible that the increase in the value of housing may be more related to economic growth, land regulations, and agglomeration effects. And the inequality of the value of housing and land may be more of a consequence of income inequality than a cause. In this case it may be that plus ça change, plus ce n’est pas la même chose.

 

Should the Fed target inflation instead of unemployment? Can it?

Cardiff Garcia has a post at the FT that argues that as the unemployment rate comes down closer to the Fed’s target of the natural rate, it should place more emphasis on it’s inflation target which it continues to miss on the low side.

This begs the question of whether or not the Fed can increase inflation in a recession when aggregate demand is low and the economy is operating well under capacity. Inflation may be “always and everywhere a monetary phenomenon” but that really just says that an increase in the money supply is a necessary condition for inflation, not that it is a sufficient condition.

I tell my students that two things are necessary for inflation: an increase in the money supply and demand to use that money to chase fewer goods. That is, if the money is sitting in a checking account (or a reserve account) and is not entering the economy, then we will not get inflation.

This is why I remain skeptical about NGDP targeting. It makes sense in the abstract to target something like 5% NGDP growth and so any lack of real GDP growth gets picked up by higher inflation. But where is the inflation coming from? If there is a lack of demand, I don’t see how the Fed can induce 7% inflation if the real economy contracts by 2%.

That said, the one country that seemed to pull it off recently was Israel. And Stanley Fischer, who has recently been appointed (but not, I believe, yet confirmed) to be the number two at the Fed, was the head of the Bank of Israel. Perhaps he can explain how it was done.

I think we all agree that schools matter

Adam Ozimek makes the argument that the Chetty et al study seems to show that higher quality schools are still the best bet for lifting children out of poverty. He seems to think that some liberals would disagree with this, but if they do, I’ve never met them.

Still, it’s a good reminder how important education is. But it’s also a bit of a smokescreen in that it blurs the distinction between the widening of the middle and the rise of the plutocrats. One could be addressed fairly easily if the other were not a threat to the existence of democracy.

The argument for full employment

Mike Konczal has a good post about the goal of “full employment” and how it should be a focus on tonight’s SOTU address.

Generally, higher unemployment is associated with lower wage growth and vice versa, although the relationship is not as strong as I would have thought. I think the proper context in which to think about this is one in which wages are at least partially determined by bargaining power.

In some of my work, I have focused on the long-term effects of union membership in the private sector and an increasing reliance on offshoring. Lower union membership and higher imports reduce the bargaining power of labor and lead to lower wage growth of the bottom 90%. But in the short term, the unemployment rate is likely to be equally important.

When there are lots of unemployed workers to choose from, firms will not be forced to pay higher wages. When the unemployment rate is very low, firms will have to bid against each other for workers, pushing wages up.

That said, we should keep in mind that wages for the bottom 90% have been fairly stagnant for the last 40 years. Years in which the unemployment rate has bounced around a fair amount. The only time we saw a strong increase in wages for the bottom 90% was in the late 1990s when the unemployment rate was very low.

That said, I think Konczal’s argument is even stronger than he makes it. There is value in work and there are significant costs associated with unemployment. If we can successfully focus on full employment, there will be benefits beyond the economics.

Of course, higher wages mean lower profits, so you can expect any full employment program to be fought tooth and nail.