US and international productivity

by John Quiggin on November 20, 2004

Over the fold, there’s a long (1500 word) piece on productivity in the US. It refers to this piece in The Economist, which was criticised by Brad DeLong. My analysis splits the difference between the two.

Anyway, I’d welcome comments and criticism.

In any assessment of the strengths and weaknesses of the US economy, productivity growth must play a central role. Most attention has been paid to positive assessments of US performance. There is plenty of good news on which to base an assessment. US productivity as measured by output per hour worked rose at an annual rate of 2.5 per cent during the dotcom boom from 1995 to 2000, considerably faster than the average for the previous 25 years.
Recessions are usually bad for productivity, as employers tend to keep workers on, even though there may be little for them to do. But no such effect was present during the US recession or the subsequent jobless recovery. Since 2000 output per hour in the nonfarm business sector has risen at an annual rate of more than 4 per cent.

However, there have been more critical interpretations of the data. A focus on productivity growth measured in terms of output per hour worked is common, but on this criterion, the United States is merely catching up to a number of European countries. The world leader in output per hour is Belgium, not normally considered an economic dynamo.

The problem here is that Belgium also has a low employment-population ratio. A lot of potential workers are either unemployed or not in the labour force, and these are presumably the less-skilled. The fact that these workers are excluded from the total increases the average, in the same way as British manufacturing productivity grew strongly under Margaret Thatcher, when large numbers of less efficient factories were forced to close.
There does not seem to be a great deal of merit in attaining high productivity levels by this route. Increased employment might reduce average output, but it would increase total output and most unemployed workers (as well as many of those who have left the labour force) would be better off in low-wage, low-productivity jobs than in their current position.

The ‘Belgium effect’ was not a problem for the United States during the ‘dotcom’ boom, which ran from 1995 to 2000. During the boom, output per hour grew strongly, at the same time as employment surged, and average hours of work increased. On the other hand, there is increasingly strong evidence that the apparent acceleration of productivity since the end of the dotcom boom is due to the exclusion of low-productivity workers. Over the period since 2000, the employment-population ratio has fallen from a peak of nearly 65 per cent, to a low of 62 per cent. There has been a slight recovery recently, but this has been associated with a slowdown in productivity growth.

As was widely noted during the recent election campaign, George Bush is the first US president since Hoover to have presided over a decline in aggregate employment. This is a surprising outcome since the recession was a relatively mild one, and output growth has been reasonably strong.
It is a matter of simple arithmetic that increasing output and declining employment must imply strongly increasing output per worker. Given that average hours worked have remained fairly stable, or declined slightly, this also implies strongly increasing output per hour.

But standard economic analysis suggests that, if productivity is increasing for all workers, employment should be increasing, not declining. A popular explanation of the observed combination of increasing (measured) productivity and declining employment is that fewer workers are needed to produce the same output. But this would make sense only if total output was constrained, for example, by inadequate demand. In the United States, by contrast, growing demand has been reflected in rapidly increasing imports.

An alternative, but related, criticism has been made by The Economist magazine. The Economist looks at multi-factor productivity, the measure most commonly used in discussions of Australia’s productivity performance. On this measure, as assessed by the OECD, the United States looks much more like the European countries with which it is commonly compared. In particular, France looks almost identical to the United States.

In both France and the United States, the rate of growth of multifactor productivity accelerated in the late 1990s. France managed multi-factor productivity growth of 1.4 per cent between 1995 and 2002, compared to 1.2 per cent in the United States. These estimates are presented by the OECD, and don’t seem to match well with national estimates (the Australian numbers are different from those produced by the ABS, though both show strong growth). In the present case, this is inevitable, since the US multi-factor productivity statistics haven’t been updated past 2001.

The Economist’s focus on multifactor productivity has been criticised by economist Brad DeLong, of the University of California, Berkeley, who argues that a major source of productivity growth is technological progress ‘embodied’ in new and improved capital goods such as computers. An improvement in the quality of capital goods is reflected in a declining quality-adjusted price. This means that, for a given level of investment spending, the quality-adjusted addition to capital stock is greater. Hence, embodied technological progress is reflected in enhanced labour productivity, but no change in capital productivity.

DeLong is right to argue that the productivity growth of recent years has been driven, in large measure, by improvements in computer and telecommunications technology, and that a measure that takes no account of this cannot be regarded as satisfactory.
On the other hand, there are two (inter-related) reasons for using MFP measures, at least in the context of international comparisons. First, since computers are commodity items nowadays, the technological progress they embody is available, on more or less equal terms, to all developed countries, with only modest time lags.

A striking illustration of this point is given by looking at the proportions of households with access to PCs and the Internet. The gap between technological leaders like the United States, and transition economies like those of Eastern Europe is less than a decade. Household internet penetration in the Czech Republic, for example, is currently 15 per cent, the level achieved by the United States in 1997. The time taken for innovations in this area to diffuse among the leading developed nations is often a matter of months, rather than years. It follows that international comparisons are unlikely to be subject to any significant bias arising from failure to take account of embodied technical change.

A second, and related point is that there are big differences in the ways in which statistical agencies different countries take account of changes in the quality of computers, and other forms of embodied technological progress. The United States uses a method called ‘hedonic regression’ which involves pricing characteristics (in the case of computers, these would include processor speed, disk drive capacity and so on) rather than specific items. By contrast, most European countries use older methods involving matching specific models. Partly because of this difference in methods, US statistical agencies generally tend to be more aggressive in quality adjustment than their European counterparts.

Most economists think that the US approach is more accurate. Regardless of which approach is right, the effect of the different approaches is to produce an upward bias in estimates of US output growth, as compared to that of European countries. As The Economist points out, any bias of this kind is matched by a corresponding bias in estimates of the volume of capital investment. In the case of MFP estimates, these two biases largely cancel out, since an overestimate (or underestimate) of the value of computers biases both the input and output measures. When these biases are eliminated, international differences in estimates of productivity growth are greatly reduced.

The resolution of these seemingly technical debates is of great importance in projecting likely future developments in the world economy. The United States is currently experiencing large and growing deficits in goods and services trade, currently equal to about 6 per cent of GDP. Such deficits cannot be sustained for more than a few years, since consistent trade deficits inevitably produce exploding current account deficits and foreign debt.
The optimistic interpretation is that the United States can accumulate debt now because international lenders anticipate high rates of productivity growth, which will permit the rapid growth in output needed to produce trade surpluses in future, thereby permitting the debt to be serviced. Against this, it may be observed that private foreign investors are increasingly unwilling to invest in the United States or buy US securities. Their place has been taken by Asian central banks, particularly the People’s Bank of China, which is trying to avoid an upward revaluation of the yuan against the dollar.

The dollar has already declined against other currencies, such as the yen and euro, and has now reached a record low against the euro. Combined with strong productivity growth, relative to the rest of the world, this ought to produce a rapid turnaround in the US trade deficit. Whether it will do so remains to be seen.

{ 26 comments }

1

Brett Bellmore 11.20.04 at 10:14 pm

It seems clear that the increase in productivity per worker couldn’t be a consequence of so small a decline in the percentage of the population working, unless those marginal workers were at best doing nothing at all, or even impeding other workers at their place of employment. So that explaination is ruled out.

2

Kevin Drum 11.20.04 at 10:36 pm

“It follows that international comparisons are unlikely to be subject to any significant bias arising from failure to take account of embodied technical change.”

That would be true only over a sufficient period of time, right? If, say, the U.S. were currently five years ahead of Europe in use of technology, it would make a pretty big difference in any 10-year comparison.

Or am I getting this wrong?

3

Giles 11.20.04 at 10:49 pm

I dont think the fall in employment is a mystery – it was higher than expected during the boom and so some inter temporal shifts in labor supply are to be expected.

Another important fact is that the capital labor share seems to have shifted a bit, which open up another difference between the mfp and labor productivity measures.

Secondly its also important to factor in that the workforce in Europe is older and so more productive than the workforce in the US.

4

John Quiggin 11.20.04 at 11:24 pm

Kevin, this is complicated by the fact that we’re mainly talking about growth rates rather than levels.

As far as technology embodied in computers and Internet connections is concerned, the gap between the US and the leading European countries is less than five years. If anything, I’d say the gap is closing slightly, but my main point is that this doesn’t look like a source of large differences in productivity growth rates.

5

rd 11.21.04 at 12:45 am

I always thought that the question of computer technology-driven productivity growth wasn’t simply a matter of adopting the technology but also of figuring out how to integrate it into business operations to maximize efficiency. So the mere fact that technology has diffused into other countries doesn’t mean they’ve yet adapted it very well. After all, the US invested in computers for years and years before any noticeable productivity gain from it materialized.

6

Matt 11.21.04 at 12:48 am

John said,
“Given that average hours worked have remained fairly stable, or declined slightly, this also implies strongly increasing output per hour”"

I’d be less sure that this is true. There was a nice article in the NY Times a day or so ago about the growing practice of making workers work off the clock. Since these hours are not counted, the hours that are counted seem to be much more productive. I can’t say, of course, how much this contributes, but here’s a story. For several years when I was in Highschool I worked for the Albertsons grocery chain, which was one of the biggest in the US. It was also the most profitable. It turned out, though, that this status was largely due to a systematic forcing of employees, particularly low-level hourly paid managers, to work off the clock, sometimes 30 or more hours per week. When this came out and they were sued, bringing at least a temporary end to the practice, then stopped being the most profitable grocery chain by a fair margin. If the story in the times is right in thinking the practice is as wide-spread as it claims, this could account of a significant amount of the supposed growth in productivity per hour- not all the hours are being counted.

7

roger 11.21.04 at 1:47 am

“The optimistic interpretation is that the United States can accumulate debt now because international lenders anticipate high rates of productivity growth, which will permit the rapid growth in output needed to produce trade surpluses in future, thereby permitting the debt to be serviced.”

Um, when was the last time there was a trade SURPLUS? Maybe 1980?
I doubt that this is a factor in international capital flows. That is, the assumption that is projected onto international lenders doesn’t really seem to explain their behavior. Another model would look like this: because the U.S. internal market is the largest in the world, the U.S. is treated differently than other countries with similar debt profiles. The system, in other words, is gamed — with the expectation not that the debt will be serviced, but that in the near future, any due debts will be serviced with a dollar that has retained its level of parity to other currencies over the last four years. The real question is what would change the equation so that international lenders: a., can absorb the dollar’s devaluation, or b., will demand such a premium to absorb the dollar’s devaluation as to generate a crisis.

This is where oil can operate as such a devilishly good hammer, to break down the walls of Conventional Wisdom that surround the myth of the strength of the American economy.

We’ll see.

8

John Quiggin 11.21.04 at 7:16 am

roger, the fact that the US has run trade deficits for 25 years does not mean that it can do so indefinitely. See here

Matt, you are correct, and I will try to fit it in to my next draft

rd, you are correct but this is captured by MFP measures.

9

messenger 11.21.04 at 7:29 am

Just where does the information about the alleged European lag of modern PC techniques come from? I would not be too complacent in that respect. Besides, time and again I have observed the early bird who adopted or expensively developed a new technology right away – often for reasons of prestige – overtaken by others, who had the sense to wait for this technology to become cheaper, easier to use and more sophisticated. For much less investment they get larger, more predictable and quicker gains in productivity.

10

abb1 11.21.04 at 11:40 am

So, productivity of labor is defined as the value of output produced per man-hour, correct? Value is measured in dollars, correct? Doesn’t it mean that any US-Europe comparison will be highly susceptible to fluctuations in the Dollar/Euro exchange rate?

Well, the Dollar has devalued against Euro by about 40% in the last few years, so how do you even start comparing? Dollar-value of what the average European man-hour produces today is 40% higher than that in 1999 even with 0 productivity increase, correct? This should make any productivity comparison (and, it seems, even productivity increase rate) pretty much meaningless, correct? What am I missing?

Thanks.

11

tom 11.21.04 at 2:53 pm

What degree of productivity would it take to compete with the Chinese? Until the U.S. can do that, all this discussion seems to be beside the point.

12

tom 11.21.04 at 2:54 pm

What degree of productivity would it take to compete with the Chinese? Until the U.S. can do that, all this discussion seems to be beside the point.

13

roger 11.21.04 at 3:52 pm

John, you rather missed my point. It may be true that the U.S. cannot keep running trade deficits; but I am not sure how it can be true, after 25 years of trade deficits, that the company or government purchasing a T note is betting on it. A better story about their motivation is needed in your analysls. The incentives, it seems to me, are mixed, but my guess is that international lenders are generally counting on the size of America’s economy to leverage its difficulties, if it ever has any, in terms of paying back its debts. If this is so, then if traders start betting against America, they may be motivated by sub-incentives — not the worry that America will economically shrink, but that America is cheapening the dollars in which it is paying back its debts. This scenario has much less to do with productivity as a factor, and more to do with the politics of credit. The government has pretty clearly signalled that it neither intends to rein in spending nor to tax to pay for it. So the third option is clearly to cheapen the money in which they pay for their borrowing. If traders gain this perception, they do have the option of going elsewhere with their money. In order to prevent that, the U.S. would have to award them some kind of premium for their willingness to loan — i.e. a greater interest rate. And if oil prices actually keep rising, this will tighten money dramatically, etc, etc. All of which might actually have the unexpected result of — making the American economy shrink. Or at least bringing about a recession of some kind. Which in turn would lead to a narrowing of the trade deficit in the old fashioned way — people would generally have less power to purchase.

14

guy 11.21.04 at 5:28 pm

Tom wrote:
>>What degree of productivity would it take to compete with the Chinese? Until the U.S. can do that, all this discussion seems to be beside the point.< <

Huh?? China’s productivity growth is probably faster than that of the US (haven’t seen the growth accounting figures — much of their fast growth presumably comes from factor accumulation), but their productivity levels in most industries are much lower.

15

ramster 11.21.04 at 7:47 pm

“The dollar has already declined against other currencies, such as the yen and euro, and has now reached a record low against the euro. Combined with strong productivity growth, relative to the rest of the world, this ought to produce a rapid turnaround in the US trade deficit. Whether it will do so remains to be seen.”

How does this square with the Chinese policy of pegging the yuan to the US dollar? Doesn’t the peg mean that the declining US dollar won’t affect trade balances between the US and China? A yuan pegged to the dollar is going to give Chinese goods the same price advantage globally that US goods would have (assuming a continuing decline in the dollar compared to other currencies). I suspect that China will see a greater trade advantage than the US in such an environment. The Europeans seem to be the prime candidates for getting screwed in this scenario (especially the big exporters). The peg doesn’t seem sustainable though. What price (if any) is China paying by maintaining the peg?

16

John Quiggin 11.21.04 at 7:59 pm

abb1, each country’s productivity growth is estimated from its own national accounts, so currency fluctuations have no (direct) effect.

roger, you’re correct, and I’ve developed most of these points in earlier posts.

ramster, the Chinese central bank will lose a lot when the yuan is eventually revalued.

17

abb1 11.21.04 at 8:49 pm

John,
doesn’t it create an escher-style paradox, when something goes up-up-up and ends up being below?

Let’s say I write essays on economics in the US and you write essays on economics in the EU. I write one essay/hour and sell it for $100 and you write one essay/hour and sell it for E100. $1=E1. We have equal productivity, correct?

Let’s say 5 years later I now write 2 essays/hour (better spell-checker) and sell them for $200. You still write 1 essay/hour and sell it for E100. But now $1=E.50. My productivity doubled. Your productivity hasn’t changed. Yet in absolute terms (value of output/hour) we still have the same prodictivity.

How is it possible?

18

John Quiggin 11.21.04 at 9:22 pm

abb1, productivity is measured in terms of quantities, so price changes are factored out.

19

abb1 11.21.04 at 9:54 pm

Well, this is odd. I always thought that productivity is measured in units of output, but some months ago I got into an argument (perhaps on this very site) and a whole group commenters convinced me that in the post-industrial society the only way to measure productivity is the dollar-value of the output.

So, I shouldn’t believe everything I read on the internet, I guess. Althought, IIRC, it did make sense at the time – to use market value instead of quantities.

But now I get it – it only matters how much stuff you produce, the quality is irrelevant. Well, that’s true – there’s a lot that going on out there. The Soviet Union probably had the highest productivity of ‘em all, just like Mr. Lenin promised – all those billions tons of iron, all those idenitical shoes and coats, millions and millions of them, probably still sitting in warehouses somewhere… Lol.

20

roger 11.21.04 at 11:34 pm

abb1, actually, the problem was that the Soviet union had notoriously bad productivity — all those pipeline workers getting drunk on the stuff they were supposed to use to defrost the pipes, all the faked stats from the outlying provinces.

If, in fact, they had produced shoddy goods for export, that wouldn’t be bad in itself. U.S. goods were notoriously shoddy in the 19th century, but they were also cheap. The Soviets embedded their imitation first world industrial infrastrucute in a third world export structure — metals, oil. And so they sank, down and down… As for Lenin, he presided, in the last year of his life, over a mixed economy experiment — NEP — which was, looking back on it, the rational way for the Soviets to evolve to the kind of welfare state political economy Sweden successfully achieved.

Although of course as any Trotskyist knows in his heart, without a Soviet Europe, the Leninist experiment was doomed anyway.

21

John Quiggin 11.21.04 at 11:36 pm

“But now I get it – it only matters how much stuff you produce, the quality is irrelevant”

On this point, reread the post.

22

Jeff Rigsby 11.22.04 at 5:20 am

Guy wrote:

“China’s productivity growth is probably faster than that of the US (haven’t seen the growth accounting figures — much of their fast growth presumably comes from factor accumulation), but their productivity levels in most industries are much lower.”

I live in Shanghai and I think this is almost certainly true. Economic growth here has been very strong for most of the past two decades or more, yet the country still has a very serious unemployment problem. In fact it appears that the job market (except for people with great English and other skills) is getting tougher and tougher *despite* the rapid growth in GDP — which implies very, very strong growth in output per worker.

There seem to be three elements driving this growth:

a) capital accumulation, as Guy suggests — the personal savings rate here is around 40 percent;

b) human-capital accumulation — levels of educational achievement are rising very quickly;

c) growth in multifactor productivity — mainly driven by the very rapid contraction of employment in agriculture and in state-owned industry (the two lowest-productivity sectors).

The last factor may become less important in future. One of the big news items here over the summer was that factories in South China are having trouble recruiting unskilled workers, because the rural labor force has begun to dry up.

Just a few thoughts from the other side of the world.

23

abb1 11.22.04 at 10:07 am

The United States uses a method called ‘hedonic regression’ which involves pricing characteristics (in the case of computers, these would include processor speed, disk drive capacity and so on) rather than specific items. By contrast, most European countries use older methods involving matching specific models.

OK, but the manufacturing sector constitutes only – what? – about 15% of the US economy? I doubt that any CPUs or hard-drives are produced by the US labor at all.

It’s mostly services and information/communication technology. How do you quantify output of a software developer: lines of code written? I guess I expected a less hazy metric for something as fundamental as ‘productivity’.

24

remi 11.22.04 at 2:31 pm

Speaking of GDP
What is the relevance of comparing the GDP of 2 countries.

For example what is the value of pizza deliveries in the US ? When most of our GDP is services and with very little % of industrial product made in US remain to be exported?

25

Guy 11.22.04 at 7:16 pm

Remi asked a bunch of questions:

< What is the relevance of comparing the GDP of 2 countries.

For example what is the value of pizza deliveries in the US ?>>

Not sure exactly what you are asking here. Pizza deliveries are counted in GDP calculation. Obviously if the underlying consumer preferences vary from country to country, this will make cross-country welfare comparisons in terms of GDP per capita (even more) dubious.

< >

Not sure what you are asking here. The US exports a lot of services since those are becoming increasingly tradeable.

26

Larry V. 11.27.04 at 1:51 am

comparing productivity per hour to anything except your own business is obsurd, the only thing productivity per hour should be measured against is your own ability to manage a profitable business,so dont kid yourself,into thinking to much about how to compare it JUST DO IT, worrying about someone else creates to much complacency about averages, move on and make money.

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