Home > Causes of Inflation, Economics, Economy, Theory > August, Productivity, and Prices

August, Productivity, and Prices


I really don’t like August. It’s nothing about the weather, or the fact that the kids are really ready to be back in school (but aren’t). I just really can’t stand the monkey business. August is, after December, probably the month in which liquidity is the thinnest; in a world with thousands of hedge funds this means that if there is any new information the market tends to have dramatic swings. More to the point, it means that if there is not any new information, the speculators make their own swings. A case in point today was the massive 5% rally in energy futures from their lows of the day back to the recent highs. There was no news of note – the IEA said that demand will balance the oil market later this year, but they have said that in each of the last couple of months too. And the move was linear, as if there had been news.

Don’t get me wrong, I don’t care if traders monkey around with prices in the short run. They can’t change the underlying supply and demand imbalance and so it’s just noise trading for noise trading’s sake. What bothers me is that I have to take time out of my day to go and try to find out whether there is news that I should know. And that’s annoying.

But my whining is not the main reason for this column today. I am overdue to write about some of the inflation-related developments that bear comment. I’ll address one of them today. (Next week, I will probably tackle another – but Tuesday is also CPI day, so I’ll post my usual tweet summary. Incidentally, I’m scheduled to be on What Did You Miss? on Bloomberg TV at 4pm ET on Tuesday – check your local listings).

I don’t spend a lot of time worrying about productivity (other than my own, and that of my employees). We are so bad at measuring productivity that the official data are revised for many years after their release. For example, the “productivity miracle” of the late 1990s, which drove the Internet bubble and the equity boom into the end of the century, was eventually revised away almost completely. It never happened.

The problem that a lot of people have with thinking about productivity is that they confuse the level of productivity with its pace of increase. So someone will say “of course the Internet changed everything and we got more productive,” when the real question is whether the pace of productivity increase accelerated. We are always getting more productive over time. There are always new innovations. What we need to know is whether those innovations and cost savings are happening more quickly than they used to, or more slowly. And, since the national accounts are exquisitely bad at picking up new forms of economic activity, and at measuring things like intellectual property development, it is always almost impossible to reject in real time the hypothesis that “nothing is changing about the rate of productivity growth.” Therefore, I don’t spend much time worrying about it.

But, that being said, we should realize that if there is a change in the rate of productivity growth it has implications for growth, but also for inflation. And recent productivity numbers, combined with the a priori predictions in some quarters that the global economy is entering a slow-productivity phase, have started to draw attention.

Most of that attention is focused on the fact that poor productivity growth lowers overall real output. The mechanism there is straightforward: productivity growth plus population growth equals real economic output growth. (Technically, more than just population growth it is working-age population growth times labor force participation, but the point is that it’s an increase in the number of workers, compounded by the increase in each worker’s productivity, that increases real output). Especially if a populist backlash in the US against immigration causes labor force growth to slow, a slower rate of productivity growth would compound the problem of how to grow real economic growth at anything like the rate necessary to support equity markets or, for that matter, the national debt.

But there hasn’t been as much focus on the other problem of low productivity growth, if indeed we are entering into that sort of era. The other problem is that low productivity growth causes higher prices, all else equal. That mechanism is also straightforward. We know that money growth plus the change in money velocity equals real output growth plus an increase in prices: that is, MV≡PQ. If velocity is mean-reverting, then the decline in real growth precipitated by a decline in labor productivity, in the context of an unchanged rate of increase in the money supply, implies higher prices. That is, if ΔM is constant and ΔV is zero and ΔQ declines, then ΔP must increase.

One partial offset to this is the fact that a permanent decline in productivity growth rates would lower the equilibrium real interest rate, which would lower the equilibrium money velocity. But that is a one-time shift while the change in trend output would be lasting.

In fact, it wouldn’t be unreasonable to suppose that the change in interest rates we have seen in the last few years is mostly cyclical but may also be partly secular. This would imply a lower equilibrium level of interest rates (although I don’t mean to imply that anything is near equilibrium these days), and a lower equilibrium level of monetary velocity. But there are a lot of “ifs” in that statement.

The biggest “if” of all, of course, is whether there really is a permanent or semi-permanent down-shift in long-term productivity growth. I don’t have a strong opinion on that, although I suspect it’s more likely true that the current angst over low productivity growth rates is just the flip side of the 1990s ebullience about productivity. We’ll know for sure…in about a decade.

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  1. HPBunker
    August 24, 2016 at 3:29 pm

    Slow productivity growth is obviously a bad thing. But I’m always a little perplexed at the media’s focus on overall GDP growth, as opposed to PER CAPITA GDP growth. It’s the latter that serves as a proxy for whether Americans’ standard of living is improving (or not). With our population growing at a steady 1% or so annually, the past three quarters of ~1% GDP growth actually translate to no improvement in our standard of living (and actually, given the inequality in income and capital gains distribution, a stagnant per capita GDP likely means a negative median per capita GDP).

    I can understand why corporate profits rise with an increasing population, but most Americans have minimal equity investments. My feeling is that real per capita GDP is not widely reported, because the number would look appallingly bad (i.e. close to 0 lately), but this sort of reporting is simply deceptive. Bringing in ~1,000,000 predominantly low-skilled immigrants each year undoubtedly raises U.S. GDP, but if anything has a negative impact on per capita GDP (since immigrants’ skills, education, and wages tend to be significantly below the mean).

    I mention all this because I have respected your writing (and generally skeptical tone) in this blog for the several years I have been following it, and I’m surprised to see you mentioning the prospect of lower immigration in a negative light. Frankly, if you’re a taxpaying American (unless you’re an employer of large numbers of immigrants and appreciate their wage suppression effect), less immigration (given current U.S. policy, which is focused almost entirely on family unification rather than skills/education) would probably improve your standard of living (as it would mean lower transfer payments to immigrant households and a higher rate of increase in real wages.

    • August 25, 2016 at 9:00 am

      Thanks. Well, I think it depends on what we think immigrants add to GDP, and what they take away, right? We can all agree that illegal immigration is bad, and immigrants who come to the US to get on the dole are bad. But there are also immigrants who are doctors, machinists, painters, housekeepers, and otherwise people who add more to GDP than they take away – probably by a lot. It’s not immediately clear to me which way that balance tips. But you’re right, GDP per capita is the right measure so it’s likely a closer call.

      Of course, if we decrease the bad kind of immigration and the good kind stays the same, then that would be an unalloyed positive. But the plans that I have heard don’t seem to distinguish well between the good and bad kinds. “Stop ’em all” seems to be growing in popularity and I think that’s a mistake.

  2. HPBunker
    August 25, 2016 at 6:07 pm

    Thanks for the reply. I think a lot of smart people who are generally well informed about significant national policy issues, are nonetheless unaware of how our legal immigration numbers break down. I know your main focus is inflation, and immigration might seem tangential to that, but it’s worth looking at the actual numbers. If you go to:

    https://www.dhs.gov/publication/yearbook-2014

    This is the official report from the Department of Homeland Security. If you download the .pdf (for 2014; the most recent year available) and scroll down to page 18 of the report, you can see that in 2014 a little over 1,000,000 immigrants were granted lawful permanent resident status. Of these, almost 700,000 were admitted under family preference categories (“family-sponsored preferences” and “immediate relatives of US citizens”) that do not consider education or job skills in any way. Only about 150,000 were admitted under “employment based preferences”. So if our goal is to address a shortage of high-skilled workers, we are obviously not doing that very efficiently; we are admitting almost five unskilled workers for every skilled worker, and this is only looking at legal immigration! Trump is a crude guy who is needlessly abrasive, but on immigration he has a point.

    • August 25, 2016 at 8:16 pm

      Thanks for the comment and adding some good color and depth to the discussion!!

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