Reading Notes: Demand and Productivity

Here are two interesting articles on demand and productivity that people have recently brought to my attention.

The economic historian Gavin Wright — author of the classic account of the economic logic of the plantation — just sent me a piece he wrote a few years ago on the productivity boom of the 1990s. As he said in his email, his account of the ‘90s is very consistent with the suggestions I make in my Roosevelt paper about how strong demand might stimulate productivity growth.

In this article, Wright traces the idea that high wage regions will experience faster productivity growth back to H. J. Habbakuk’s 1962 American and British Technology in the Nineteenth Century. Then he assembles a number of lines of evidence that rapid wage growth drove the late-1990s productivity acceleration, rather than vice versa.

He points out that the widely-noted “productivity explosion” of the 1920s — from 1.5 percent a year to over 5 percent — was immediately preceded by a period of exceptionally strong wage growth: “The real price of labor in the 1920s … was between 50 and 70 percent higher than a decade earlier.” [1] The pressure of high wages, he suggests, encouraged the use of electricity and other general-purpose technologies, which had been available for decades but only widely adopted in manufacturing in the 1920s. Conversely, we can see the productivity slowdown of the 1970s as, at least in part, a result of the deceleration of wage growth, which — Wright argues — was the result of institutional changes including the decline of unions, the erosion of the minimum wage and other labor regulations, and more broadly the shift back toward “‘flexible labor markets,’ reversing fifty years of labor market policy.”

Turning to the 1990s, the starting point is the sharp acceleration of productivity in the second half of the decade. This acceleration was very widely shared, including sectors like retail where historically productivity growth had been limited. The timing of this acceleration has been viewed as a puzzle, with no “smoking gun” for simultaneous productivity boosting innovations across this range of industries over a short period. But “if you look at the labor market, you can find a smoking gun in the mid-1990s. … real hourly wages finally began to rise at precisely that time, after more than two decades of decline. … Unemployment rates fell below 4 percent — levels reached only briefly in the 1960s… Should it be surprising that employers turned to labor-saving technologies at this time?” This acceleration in real wages, Wright argues, was not the result of higher productivity or other supply-side factors; rather “it is most plausibly attributed to macroeconomic conditions, when an accommodating Federal Reserve allowed employment to press against labor supply for the first time in a generation.”

The productivity gains of the 1990s did, of course, involve new use of information technology. But the technology itself was not necessarily new. “James Cortada [2004] lists eleven key IT applications in the retail industry circa 1995-2000, including electronic shelf levels, scanning, electronic fund transfer, sales-based ordering and internet sales … with the exception of e-business, the list could have come from the 1970s and 1980s.”

Wright, who is after all a historian, is careful not to argue that there is a general law linking higher wages to higher productivity in all historical settings. As he notes, “such a claim is refuted by the experience of the 1970s, when upward pressures on wages led mainly to higher inflation…” In his story, both sides are needed — the technological possibilities must exist, and there must be sufficient wage pressure to channel them into productivity-boosting applications. I don’t think anyone would say he’s made a decisive case , but if you’re inclined to a view like this the article certainly gives you more material to support it.


A rather different approach to these questions is this 2012 paper by Servaas Storm and C. W. M. Naastepad. Wright is focusing on a few concrete episodes in the history of a particular country, which he explores using a variety of material — survey and narrative as well as conventional economic data. Storm and Naastepad are proposing a set of general rules that they support with a few stylized facts and then explore via of the properties of a formal model. There are things to be learned from both approaches.

In this case the model is simple: output is demand-determined. Demand is either positive or negative function of the wage share (i.e. the economy is either wage-led or profit-led). And labor productivity is a function of both output and the wage, reflecting two kinds of channels by which demand can influence productivity. And an accounting identity says that employment growth is qual to output growth less labor productivity growth. The productivity equation is the distinctive feature here. Storm and Naastepad adopt as “stylized facts” — derived from econometric studies but not discussed in any detail — that both parameters are on the order of 0.4: An additional one percent growth in output, or in wages, will lead to an 0.4 percent growth in labor productivity.

This is a very simple structure but it allows them to draw some interesting conclusions:

– Low wages may boost employment not through increased growth or competitiveness, but through lower labor productivity. (They suggest that this is the right way to think about the Dutch “employment miracle of the 1990s.)

– Conversely, even where demand is wage-led (i.e. a shift to labor tends to raise total spending) faster wage growth is not an effective strategy for boosting employment, because productivity will rise as well. (Shorter hours or other forms of job-sharing, they suggest, may be more successful.)

– Where demand is strongly wage-led (as in the Scandinavian countries, they suggest), profits will not be affected much by wage growth. The direct effect of higher wages in this case could be mostly or entirely offset by the combination of higher demand and higher productivity. If true, this has obvious implications for the feasibility of the social democratic bargain there.

– Where demand is more weakly wage-led or profit-led (as with most structuralists, they see the US as the main example of the latter), distributional conflicts will be more intense. On the other hand, in this case the demand and productivity effects work together to make wage restraint a more effective strategy for boosting employment.

It’s worth spelling out the implications a bit more. A profit-led economy is one in which investment decisions are very sensitive to profitability. But investment is itself a major influence on profit, as a source of demand and — emphasized here — as a source of productivity gains that are captured by capital. So wage gains are more threatening to profits in a setting in which investment decisions are based largely on profitability. In an environment in which investment decisions are motivated by demand or exogenous animal spirits (“only a little more than an expedition to the South Pole, based on a calculation of benefits to come”), capitalists have less to fear from rising wages. More bluntly: one of the main dangers to capitalists of a rise in wages, is their effects on the investment decisions of other capitalists.

One thought on “Reading Notes: Demand and Productivity”

  1. If I understand the Rehn–Meidner model, the idea was to put pressure on less productive sectors and drive investment into more productive sectors, while keeping wages high for all. The “Dutch employment miracle” in the Storm and Naastepad paper kind of sounds like the opposite.

    Let’s say you became Assistant Secretary of the Treasury in 2021 (don’t laugh, it’s gonna happen) and everybody is on board with your report. A few years pass, wages and productivity are up, and it’s your job to figure out roughly what the right level of wage growth, etc should be. If I understand this correctly, the idea is to keep enough pressure on wages to force capitalists into making productivity-enhancing investment. What indicators are you looking at to see that things are working? What happens if profits decline and investment dries up or moves elsewhere? I want this to work but it seems too good to be true.

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