Tag: mysteries of the 1970s

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.

The Story of Q

More posts on Greece, coming right up. But first I want to revisit the relationship between finance and nonfinancial business in the US.

Most readers of this blog are probably familiar with Tobin’s q. The idea is that if investment decisions are being made to maximize the wealth of shareholders, as theory and, sometimes, the law say they should be, then there should be a relationship between the value of financial claims on the firm and the value of its assets. Specifically, the former should be at least as great as the latter, since if investing another dollar in the firm does not increase its value to shareholders by at least a dollar, then that money would better have been returned to them instead.

As usual with anything interesting in macroeconomics, the idea goes back to Keynes, specifically Chapter 12 of the General Theory:

the daily revaluations of the Stock Exchange, though they are primarily made to facilitate transfers of old investments between one individual and another, inevitably exert a decisive influence on the rate of current investment. For there is no sense in building up a new enterprise at a cost greater than that at which a similar existing enterprise can be purchased; whilst there is an inducement to spend on a new project what may seem an extravagant sum, if it can be floated off on the Stock Exchange at an immediate profit. Thus certain classes of investment are governed by the average expectation of those who deal on the Stock Exchange as revealed in the price of shares, rather than by the genuine expectations of the professional entrepreneur.

It was this kind of reasoning that led Hyman Minsky to describe Keynes as having “an investment theory of the business cycle, and a financial theory of investment.” Axel Leijonhufvud, on the other hand, would warn us against taking the dramatis personae of this story too literally; the important point, he would argue, is the way in which investment responds to the shifts in the expected return on fixed investment versus the long-term interest rate. For better or worse, postwar Keynesians including the eponymous Tobin followed Keynes here in thinking of one group of decisionmakers whose expectations are embodied in share prices and another group setting investment within the firm. If shareholders are optimistic about the prospects for a business, or for business in general, the value of shares relative to the cost of capital goods will rise, a signal for firms to invest more; if they are pessimistic, share prices will fall relative to the cost of capital goods, a signal that further investment would be, from the point of view of shareholders, value-subtracting, and the cash should be disgorged instead.

There are various specifications of this relationship; for aggregate data, the usual one is the ratio of the value corporate equity to corporate net worth, that is, to total assets minus total liabilities. In any case, q fails rather miserably, both in the aggregate and the firm level, in its original purpose, predicting investment decisions. Here is q for nonfinancial corporations in the US over the past 60 years, along with corporate investment.

The orange line is the standard specification of q; the dotted line is equity over fixed assets, which behaves almost identically. The black line shows nonfinancial corporations’ nonresidential fixed investment as a share of GDP. As you can see, apart from the late 90s tech boom, there’s no sign that high q is associated with high investment, or low q with low investment. In fact, the biggest investment boom in postwar history, in the late 1970s, comes when q was at its low point. [*]

The obvious way of looking at this is that, contra Tobin and (at least some readings of) Keynes, stock prices don’t seem to have much to do with fixed investment. Which is not so strange, when you think about it — it’s never been clear why managers and entrepreneurs should substitute the stock market’s beliefs about the profitability of some new investment for their own, presumably better-informed, one. Just as well, given the unanchored gyrations of the stock market.

This is true as far as it goes, but there’s another way of looking at it. Because, q isn’t just uncorrelated with investment; for most of the period, at least until the 1990s, it’s almost always well below 1. This is even more surprising when you consider that a well-run firm with an established market ought to have a q above one, since it will presumably have intangible assets — corporate culture, loyal customers and so on — that don’t show up on the balance sheet. In other words, measured assets should seem to be “too low”. But in fact, they’re almost always too high. For most of the postwar period, it seems that corporations were systematically investing too much, at least from the point of view maximizing shareholder value.

I was talking with Suresh the other day about labor, and about the way labor organizing can be seen as a kind of assertion of a property right. Whether shareholders are “the” residual claimants of a firm’s earnings is ultimately a political question, and in times and places where labor is strong, they are not. Same with tenant organizing — you could see it as an assertion that long-time tenants have a property right in their homes, which I think fits most people’s moral intuitions.

Seen from this angle, the fact that businesses were investing “too much” during much of the postwar decades no longer is a sign they were being irrational or made a mistake; it just suggests that they were considering the returns to claimants other than shareholders. Though one wouldn’t what to read too much into it, it’s interesting in this light that for the past dozen years aggregate q has been sitting at one, exactly where loyal agents for shareholders would try to keep it. In liberal circles, the relatively low business investment of the past decade is often considered a sign of something seriously wrong with the economy. But maybe it’s just a sign that corporations have learned to obey their masters.

EDIT: In retrospect, the idea of labor as residual claimant does not really belong in this argument, it just confuses things. I am not suggesting that labor was ever able to compel capitalist firms to invest more than they wanted, but rather that “capitalists” were more divided sociologically before the shareholder revolution and that mangers of firms chose a higher level of investment than was optimal from the point of view of owners of financial assets. Another, maybe more straightforward way of looking at this is that q is higher — financial claims on a firm are more valuable relative to the cost of its assets — because it really is better to own financial claims on a productive enterprise today than in the pr-1980 period. You can reliably expect to receive a greater share of its surplus now than you could then.

[*] One of these days I really want to write something abut the investment boom of the 1970s. Nobody seems to realize that the highest levels of business investment in modern US history came in 1978-1981, supposedly the last terrible days of stagflation. Given the general consensus that fixed capital formation is at the heart of economic growth, why don’t people ask what was going right then?

Part of it, presumably, must have been the kind of sociological factors pointed to here — this was just before the Revolt of the Rentiers got going, when businesses could still pursue growth, market share and innovation for their own sakes, without worrying much about what shareholders thought. Part must have been that the US was still able to successfully export in a range of industries that would become uncompetitive when the dollar appreciated in the 1980s. But I suspect the biggest factor may have been inflation. We always talk about investment being encouraged by stuff that makes it more profitable for capitalists to hold their wealth in the form of capital goods. But logically it should be just as effective to reduce the returns and/or safety of financial assets. Since neither nominal interest rates nor stock prices tracked inflation in the 1970s, wealthholders had no choice but to accept holding a greater part of their wealth in the form of productive business assets. The distributional case for tolerating inflation is a bit less off-limits in polite conversation than it was a few years ago, but the taboo on discussing its macroeconomic benefits is still strong. Would be nice to try violating that.