Plausibility, Continued

Real output per worker, 1921-1939:



The Depression didn’t just see a fall in employment, it saw a fall in the output of those still employed, reversing much of the productivity gains of the 1920s. (This surprised Keynes, among others, who still believed in the declining marginal product of labor, which predicted the opposite.) Recovery in the late 1930s, conversely, didn’t just mean higher employment, it involved a sharp acceleration in labor productivity. There’s a widespread idea that output per worker necessarily reflects supply-side factors — technology, skills, etc. But if demand had such direct effects on labor productivity in the Great Depression, why not in the Lesser Depression too? But for some reason, people who scoff at the idea of the “Great Forgetting” of the 1930s have no trouble believing that the drastic slowdown in productivity growth of recent years has nothing to do with the economic crisis it immediately followed.


EDIT: I should add: While the decline in production during the Depression was, of course, primarily a matter of reduced employment, the decline in productivity was not trivial. If output per employee had continued to rise in the first half of the 1930s at the same rate as in 1920s, the total fall in output would have been on the order of 25 percent rather than 33 percent.

Note also that the only other comparable (in fact larger) fall in GDP per worker came in the immediate postwar demobilization period 1945-1947. I’ve never understood the current convention that says we should ignore the depression and wartime experience when thinking about macroeconomic relationships. Previous generations thought just the opposite — that we can learn the most about how the system operates from these kinds of extreme events, that “the prime test of Keynesian theory must be the Great Depression.” Isn’t it logical, if you want to understand how shifts in aggregate demand affect economic outcomes, that you would look first at the biggest such shifts, where the effects should be clearest? The impact of these two big demand shifts on output per worker, seem like good reason to expect such effects in general.

And it’s not hard to explain why. In real economies, there are great disparities in the value of the labor performed by similar people, and immense excess capacity in the form of low-productivity jobs accepted for lack of anything better. Increased demand mobilizes that capacity. When the munitions factories are running full tilt, no one works shining shoes.

16 thoughts on “Plausibility, Continued”

  1. Though aren’t committing the Sin of Krugman? I remember he got lots of flack (and I think I basically agree) for assuming that the economy returns to a long term trend line automatically. Was he talking about a much longer trend line than you are? Cheers.

    1. Well, tis is interesting. On the one hand, that’s my point — until quite recently, it was unquestioned conventional wisdom that output should always return to trend, so the Friedman numbers would at most be getting us where we would end up anyway a little quicker. In a certain sense, the new orthodoxy that demand shocks are actually persistent, is a step forward, at least intellectually. But it’s still the case that (1) if the CBO was predicting in 2006 that the US economy could be producing $25 trillion worth of stuff by 2024, it shouldn’t be considered entirely crazy to continue to still believe that’s what it’s capable of today. And (2) if demand shocks are persistent, that goes both ways. In that sense, I think arguments like DeLong’s here actually make the case for mega-stimulus stronger, not weaker. Because if unemployment and low investment shrink the laborforce and slow down innovation, then logically low unemployment and high investment must do the opposite.

      1. So this is basically the idea of hysteresis? Is it not then a widely accepted idea in m.s. macro? It does make sense if you’ve got hysteresis as a characterization moving to a suboptimal path, that you could move to a better path as well through sustained high employment
        (almost as if the health and well-being of the population mattered ;->)

  2. Here are some more links to the issue
    Narayana Kocherlakota says maybe we could have 5+% growth for several years

    Mark Thoma says something similar in

    Brad Delong says Friedman is wrong but he won’t commit to saying whether he agrees with Thoma or Kocherlakota (Krugman doesn’t believe them and seems to believe we’re stuck at around 2.0 growth for a while)

    Noah Smith says what all the anti-Sanders pundits (eg Krugman) is really arguing about is whether or not Sanders spending plans require any tax hikes at all: “Krugman, etc. aren’t arguing against Sanders’ spending plans, they’re arguing against believing that they’ll pay for themselves.”

  3. It seems to me that if you believe (like Krugman does) that wages don’t fall as they should according to market conditions in depressed economic conditions, you almost MUST also believe that productivity will fall in depressed economic conditions (where by “fall” I mean “lag behind what it would be without the demand shortfall”). Or am I misunderstanding somethings (likely – not an economist)? Not to mention that employers esp. in high productivity industries will be reluctant to reduce labor by as much as weak demand would dictate, for fear of losing qualifications.

  4. I think that the fall in productivity is only apparent, and is caused by a situation of underconsumption.
    For example, suppose that during a boom a worker produces 10 muffins, and has a wage of 8 muffins.
    When the recession hits, some of the 10 will go unsold, some companies will close, and the worker’s wage will fall.
    For example, some companies close down, worker’s wage falls to 7 muffins, but of the 10 potentially produced muffins 2 ether go unsold or simply aren’t produced, so that:
    a) The “effective” productivity of the worker now is just 8 muffins;
    b) The “effective” wage share of the worker in fact rose from 80% to 7/8 (85%), even though worker’s wage actually fell (this is IMHO what is happening in Italy, at least in part).

    Now it’s true that in this situation owners have resons to close down industries, but as they do, they effect negatively demand, so that there still remains a wedge between the true productivity and the “effective” (apparent) productivity.

    PS: I’m currently fascinated by Goodwin’s model and this is part of my super-duper version of the model, that someday I’ll write down and will explain everything in the world, mwahahahaha.

  5. Unfortunately this whole discussion now revolves around “5.3” (or “9.7”) and the onus is on Sanders to explain it. Instead of arguing about the (economic) feasibility of the whole package I think it will be useful to analyze different scenarios: for ex., how does the program work if we exclude min. wage $15 (or “free” college) but keep everything else, especially single-payer? I think this is the way things are going to work even if Sanders got to do it. I am especially disappointed with the lack of a good discussion focused on single-payer vis-à-vis Mr Thorpe’s critique of the same.

    1. Well, it’s a different conversation. But I think it’s quite important to hash out how much growth we think is possible — or more precisely, how much overall stimulus is desirable.

      To me the discussion of the specific proposals seems less pressing since they are going to be shaped by the political environment. But it’s essential to get a general commitment to more aggressive stimulus now if we want to be able to take advantage of whatever opportunities arise.

  6. I find that economists too often get lost in the weeds of rear-view statistics.

    A broader perspective:
    At its core money is simply a measure of Human activity. All production (raw materials, engineering, manufacturing, distribution, services, etc) is ultimately intended to satisfy Human consumption. So, if humanity were on a level, economic, playing field, GDP growth could only match the pace of population growth.

    Particularly after WWII, US GDP growth was high because much of the developed world was being restored from devastation & the under-developed world toiled under repressive totalitarian regimes, or simply subsisted.

    Now, we have 1.4B Chinese, 1.3B Indians, the old Soviet block & others in a global competition to all reach “middle-class”. For a while, China inflated GDP growth by government artifice & popular avarice. India, having English as a strong second language & with reverence for education, is benefiting from a global diaspora of in-demand hi-tech workers. The former Soviets have capitalized on a refined & wide-spread cleptocracy.

    Bottom line: This world-wide democratization of the 1% vs the 99% is resulting in GDP growth reverting to its underlying trajectory – world population growth, specifically 1%. Apparent & transitory deviations from this 1%, such as the current ‘~5%’ GDP growth in China, simply reflects a [4%] transfer of wealth from developed nations to a developing nation – not real growth!

    What’s the evidence? The US $19T debt & growing; the sociopolitical turmoil resulting from an impoverished US middle-class; the sluggish US 2% GDP growth, despite a ‘4.9%’ unemployment rate; the impending displacement of vast swaths of labor by robots/AI, etc.

    Plan on a 2% & declining GDP growth rate, unless WWIII once more resets the world economies.

  7. Justin Wolfers wrote an Upshot column at the NYTimes entitled “Uncovering the Bad Math (or Logic) of an Economic Analysis Embraced by Bernie Sanders” today, in which he discusses the key error/discrepancy in the Friedman analysis. Essentially, Friedman assumes that the stimulus effect of a temporary government spending program continues indefinitely, well after the program ends. Here is the closing section of the column:

    Here’s why this matters. Mr. Friedman claims to “make a conservative estimate of the stimulative effect of the Sanders program by using a relatively low spending multiplier.”

    The multiplier is a number that quantifies how strongly government spending influences output. He relies on the Congressional Budget Office for estimates of the multiplier, and shades them a little, which makes them appear conservative. The multiplier he uses is on average 0.89. In the Congressional Budget Office models that he’s drawing from, this means that if the government spends $100 more today, output will rise by $89 this year, but when that stimulus is withdrawn next year, output will then fall back to its earlier level.

    From start to finish, that $100 extra government spending yields $89 worth of more stuff. By contrast, in Mr. Friedman’s figures, output stays $89 higher each year, forever. Over a 10-year period, this means that $100 of government spending yields a total of $890 worth of more stuff, implying a 10-year multiplier of 8.9.

    This is not a conservative estimate; it’s so high that I know of no study that suggests such large effects, nor of any economist who would defend this view. This is why Ms. and Mr. Romer say that Mr. Friedman’s “estimates of the likely demand effects are dramatically higher than standard approaches imply,” and that his estimates are “not just implausibly large, but literally incredible.”

    When I pointed Mr. Friedman to this critique of his analysis, he simultaneously accepted and rejected it.

    He accepted it, telling me that “I may have made a mistake.”
    But he also rejected this critique, arguing that his figures are based on an alternative view of the world, stating: “To me, when the government spends money, stimulates the economy, hires people who spend, that stimulates more private investment. That remains, and at the next year, you’re starting at the higher level.” He admits that this “is not standard macro,” and described it as the understanding of an earlier generation of economists — a sub-tribe of Keynesians he called “Joan Robinson Keynesians.” (Joan Robinson was a contemporary of John Maynard Keynes at Cambridge.)

    When I pressed Mr. Friedman on whether he was right to conclude that standard assumptions suggest that Mr. Sanders’s economic program will have such large effects, he said, “I have to stop saying ‘standard.’ ” It became apparent in our conversation that he simply hadn’t realized that he had mischaracterized mainstream economics, leading him to describe his disagreement with Ms. and Mr. Romer as “a measure of my ignorance of modern macro, and my disagreements with modern macro.”

    1. Again, I didn’t start writing about this to defend or endorse Jerry’s paper, and nothing I’ve said depends on his specific numbers. He can defend those himself (hopefully more effectively than he did here.) But even if you throw out the Friedman paper entirely, that doesn’t weaken the argument for policies to raise demand.

  8. Here my contribution.

    Male participation rates are in fact pretty boring. All the action was, and still is, in female participation rates (look also at the 55+generation). Aside: fast productivity growth after a slump is at first often due to diminishing slack. In the thirties there however seem to have been extra ordinary productivity surprises (electricity, trucks combined with better roads etcetera) which might well be one of the reasons why unemployment was persistently high an only the extreme war effort (and after WW II the welfare state and the weekend) got unemployment down. This was beyond almost anyone´s imagination during the thirties (alas not beyond the imagination of a German maniac who, alas, happened to employ the most able central banker of the twentieth century).

  9. Where do the WTO and progressive liberalisation fit into all this?

    It seems to me, and I’ve been looking at this problem for two weeks now, trying to find some way you-all would be right, but my conclusion is that you economists are all being deceived along with almost everybody else.

    The whole New Deal was quietly, systematically outlawed by the Clintons, Bush, Obama and WTO. And now TiSA.

    Did ANY non-trade involved Americans ‘get the memo’?


    Prove me wrong, if I am. Please.

  10. You know I read a stat the other day I have never known before about the GD and how that a huge portion of those employed were only employed part time in 32. Conceivably a source of lost productivity? (Not that I want that to be true but curiosity you know…)

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