Doing less with more

COUNTRIES grow richer when they learn how to produce more valuable stuff per person. Sadly, many advanced economies seem to have lost the knack. Except for a brief spurt around the turn of the millennium, productivity has grown painfully slowly in rich countries over the last four decades (see chart)—a factor, economists reckon, that has contributed to stagnant pay. Labour productivity in America fell at a startling 2.2% annual pace in the fourth quarter of 2015; growth of 0.6% for the year as a whole was better, but hardly impressive.

Orthodox explanations for the problem tend to fall into one of three categories. The first, championed by Robert Gordon, an economist at Northwestern University, suggests humanity has run out of big ideas.* Recent technological advances, the argument goes, lack the transformative power of the inventions of the 19th and early 20th centuries. Electricity and indoor plumbing, in Mr Gordon’s view, altered lives in a far more fundamental way than the digital revolution has managed. We were promised flying cars, to paraphrase Peter Thiel, a venture capitalist, but wound up instead with social networks.

There are several inconsistencies in this story, however. Recent developments in artificial intelligence and robotics look at least as transformative as the gains in software and computing that powered the productivity boom of the late 1990s. The breadth of the productivity slowdown also poses a problem for Mr Gordon’s thesis. Productivity growth has slumped not just in the rich world, but also in developing countries such as Mexico and Turkey, which should be able to boost efficiency easily by adopting the productivity-boosting technology that is already in use in wealthier places.

Some optimists argue instead that the problem is one of measurement. Technological progress often raises productivity in ways that statistical agencies struggle to detect. The tumbling cost of digital media (vast amounts of which are in effect free) subtracts from measured GDP, for example. Meanwhile, huge improvements in the quality of goods like smartphones can be difficult for statistical agencies to capture.

Yet mismeasurement probably plays only a small role in the slowdown. Chad Syverson of the University of Chicago estimates that the productivity slump has cost America about $2.7 trillion in lost output since 2004, or about $8,400 for every American. That is far more than most estimates of the unmeasured gains from information technology. New research presented at the Brookings Institution, a think-tank, by David Byrne and John Fernald of the Federal Reserve and Marshall Reinsdorf of the IMF suggests there is little reason to think that the official data are worse now than in the late 1990s, when measured productivity growth was much higher. Indeed, the data ought to have improved, since the smartphones and computers that give statisticians such headaches are no longer made in the rich world.

A third, more worrying possibility is that ossifying rich economies are getting worse at shifting people from obsolete firms and stagnant towns to more productive ones. In America, for instance, the rate of startup formation has fallen steadily since the late 1980s, according to work by Jorge Guzman and Scott Stern of MIT. That is not as disconcerting as it sounds: the authors find that the American economy is still producing plenty of the right sort of firms, with lots of growth potential. Worryingly, however, fewer of those firms seem to grow big.

A few, high-growth startups account for most new jobs created in the private sector. But over the past 15 years America’s high-growth companies have not expanded much faster than their plodding peers. Flagging competitive pressures could be to blame. Profitable firms are increasingly likely to bank their earnings than to plough them back into the business. Regulation may also be a problem. Messrs Guzman and Stern find that entrepreneurial potential in some places, such as San Francisco and its hinterland, is far larger than in others, such as Detroit. Yet restrictions on construction constrain the movement of people from stagnant places to dynamic ones. A paper published in 2015 by Chang-Tai Hsieh of the University of Chicago and Enrico Moretti of the University of California, Berkeley, suggested that if it were easier to build in and around San Francisco, and thus cheaper to live there, employment in the area would rise by more than 500%, while many cities in the Rust Belt would all but vanish.

Waste not, want not

Orthodox economics suggests plenty of ways to nurture productivity growth—and, with luck, wages—such as boosting support for research and cutting red tape. But some in the profession are also beginning to ask whether the link between low productivity and low wages may run in both directions. Low pay allows firms to employ workers profitably in marginal jobs and to continue to use workers even though robots or software could replace them. Investments in automated checkout machines, for example, are less attractive when there are lots of cheap humans around.

Some economists, such as João Paulo Pessoa and John Van Reenen of the London School of Economics, reckon low British wages, which tumbled during the Great Recession, help account for weak productivity growth during the subsequent recovery, since firms felt less pressure to economise. Similarly, abundant, cheap labour may help explain how the American economy has managed to produce the unusual combination of soaring employment and weak wage growth in recent years.

By allowing economies to operate with lots of labour-market slack and by relying on falling pay to boost competitiveness, governments have enabled firms to make careless use of low-wage labour. By prioritising a return to full employment, politicians could give a much-needed kick to both wages and productivity.

Sources:

“The Rise and Fall of American Growth: The US Standard of Living Since the Civil War”, Robert Gordon, 2016.

“Challenges to mismeasurement explanations for the US productivity slowdown”, Chad Syverson, NBER Working Paper 21974, January 2016.

“Does the United States have a productivity slowdown or a measurement problem?”, David Byrne, John Fernald and Marshall Reinsdorf, Brookings Papers on Economic Activity, Spring 2016.

“The state of American entrepreneurship? New estimates of the quantity and quality of entrepreneurship for 15 US states, 1988-2014”, Jorge Guzman and Scott Stern, 2016.

"Where has all the skewness gone? The decline in high-growth (young) firms in the US", Ryan Decker, John Haltiwanger, Ron Jarmin and Javier Miranda, NBER Working Paper 21776, December 2015.

“Why do cities matter? Local growth and aggregate growth”, Chang-Tai Hsieh and Enrico Moratti, NBER Working Paper 21154, May 2015.

“The UK productivity and jobs puzzle: Does the answer lie in labour market flexibility?”, Joao Paulo Pessoa and John Van Reenen, Centre for Economic Performance Special Paper, June 2013.