TCS Daily

It's the Productivity, Stupid

By Tim Worstall - July 13, 2006 12:00 AM

We've all seen the "Why oh Why" pieces floating around about the economy? Why, if productivity is booming, GDP growth is strong, oh why is the labor market weaker than we think it ought to be? Why aren't Joe Six-pack's wages soaring and why are profits rising so strongly? Well, here's why: productivity is booming.

A useful introduction to the situation is this by Jared Bernstein over at the blog MaxSpeak:

Let us begin with a few observations:

Over the course of the current economic expansion, real GDP is up 15%.

The Congress is busy killing a moderate minimum wage increase while working diligently to repeal the estate tax.

Profits as a share of national income are at a forty-year high. The share of income accruing to the top 1%, after falling in the wake of the bust, is again on the rise.

Productivity is up a stellar 15% over this recovery. Real hourly wages of non-managers are up bupkes (-0.6%).

New economy cheerleaders expound on the great job market, yet employment growth is up only 2% over this business cycle. The growth for the comparable period over the 1990s cycle was 7% and the historical average for cycles of this length was 10%.

Rather than try and argue each point separately or in detail (for example, real wages are not the same as real compensation, which has been rising, neither the minimum wage nor the estate tax affect real hourly wages so as you'd notice and so on) let's take the major points as they are.

Real GDP and productivity have risen by the same amount, wages haven't budged, profits have surged and so has the income of the top 1 percent. The interesting question now is exactly the why oh why? one. Why have all of these things been happening?

There are a number of possible theories, of course. Perhaps Karl Rove personally contacts each and every CEO to remind them not to raise wages so as to benefit Republicans? If that were actually happening I tend to think that those of my friends who are CEOs might tell me, perhaps let it slip in a moment of beery introspection: maybe they don't because they'd have to kill me afterwards? Too difficult to get the blood off that mink-lined limo perhaps?

Perhaps such explanations should be better left to the tinfoil hat brigade. Part of what I think is the true answer comes from The Economist:

But by some other measures, the labour market is weak. Real wages for the median worker in America have been stagnant during this business cycle, although economic growth was running at an annualised pace of 5.6% in the first quarter. Corporate demand for labour has not been growing fast enough, apparently, to drive up wages.

What we need is a mechanism (one that preferably does not involve unlikely and nefarious conspiracies) to explain our observed facts. One that is explained in an essay in this book, Flying on One Engine, a collection of pieces from Wall Street economists from a couple of years ago. John P. Lipskey and James E. Glassman (not to be confused with TCS Daily host James K. Glassman; these writers are both economists at JP Morgan Chase) where they say this:

In particular, total employment will not expand unless the economy grows faster than businesses are able to boost productivity. Thus, the "hurdle" rate for job growth -- that is, the minimum rate of GDP growth needed to produce net job gains -- will vary over time, depending upon how successful companies are in improving their productivity.


...that is, if productivity continued to advance at the exceptional rate of the past year or so [they were writing in 2004-Ed] the implication is that profit margins would soar, despite a starting point of record highs.

I think that provides our answer. Yes, it is true that productivity has been rising strongly.

My own view is that we are going through something of a step change in the economy. While, as we know, a lot of the productivity growth of the 1990s was actually the computer industry itself becoming more efficient at its own manufacturing, the current boom is from people working out what to actually do with the bright shiny boxes. In this view, the internet is as world-changing an invention as the car, and we have now a one-off boost in productivity growth. It might last for another 6 months or another six years, no one really knows.

But that productivity rise is indeed there, all are agreed upon that. As above, in order for there to be strong growth in the demand for labor, GDP growth has to be higher than the rise in productivity. If a company can expand its output to meet the market demands simply by internal efficiency improvements (which is what productivity means to some extent) why should they go out and hire more labor? Further, if there is no strong demand for more labor, why would wages rise?

We can even explain the rise in corporate profits from this model: the extra money has to be going somewhere and if there's no general inflation then it isn't going on physical inputs, if wages aren't rising then it's not going to labor, what is there left: profits. As the top 1 percent get more of their income from profits than any other group in the economy, we can even, with this very simply model, explain why their income is going up too.

The next question might be what are we going to do about all of this? My reaction would be nothing, as I can't think of anything that would not make things worse. A Keynesian might argue that the solution is even greater boosting of demand to boost GDP growth but this would require greater than present governmental deficit spending: not a solution likely to appeal to anyone just at present. We could try to artificially slow down the productivity growth (say, set OSHA or the EPA loose on business) but that would violate the most important precept that economists have about wealth generation: productivity isn't everything but in the long run it's almost everything (© Paul Krugman). Or we could simply wait. At some point this surge in productivity will work itself out, GDP growth will be higher than that growth and employment and wages will rise naturally.

However, I will admit to liking this argument precisely because of its circularity. The question as so often posed is, if productivity is rising so quickly, as fast as GDP, why isn't the labor market tight and wages similarly booming? The answer being, the labor market isn't tight and wages are not booming because productivity is rising so quickly, as fast as GDP.

The only question that remains, as far as I can see, is why the original question therefore causes such puzzlement? Why do we have all of those "Why, oh why?" pieces when the answer is "because"?

Tim Worstall is a TCS Daily contributing writer living in Europe.


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