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Posted on 6 Mar 2017 by Steve Johnson
They get the blame for a lot these days. Asset bubbles, moral hazard, banking crises, deflation, inflation. It’s all the fault of the central bankers.
Some of the criticism is warranted. Some of it is not. As Sebastian Mallaby concluded in his excellent biography of Alan Greenspan, central bankers don’t have the power many people attribute to them. One contributor to the financial crisis was the widespread assumption that Greenspan had the power to avert it.
But I would like to lay one more issue at the central bankers’ feet. Is the long term decline in productivity growth a consequence of modern monetary policy?
Before I speculate on that question, a quick aside.
The importance of productivity
Productivity is the most important factor in increasing standards of living. We can argue about whether one country is taking more than their fair share of the pie. We can argue about how the pie should be split between capital and workers, between the educated and not so educated. But there is only one way of growing the average economic pie per person, and that is to produce more with the same amount of inputs. We need to get more “productive”.
The capitalist system has been wonderfully adept at achieving this over the past few centuries. The profit motive encourages new inventions and ideas that increase output per person. Competition forces people to come up with more efficient ways of doing things.
Since the early 1970s, however, the rate of productivity growth has been declining in the developed world. There are many theories as to why. Some argue that all the big ideas have already been found. Is the iPhone, for example, that big of a deal relative to the automobile? Others suggest we simply aren’t measuring the modern economy well. Where, for example, does the US$30bn of joy that Snapchat brings to the world show up in GDP figures?
One theory I haven’t seen, though, is that the central bankers are to blame. I don’t mean that directly. Glenn Stevens wasn’t running around personally knocking good ideas on the head. But indirectly, through stifling the economic cycle, have central bankers been stifling productivity growth?
Last night I was chatting with Gareth about Subsea7. This former member of our International Fund is shaping up alongside Sotheby’s as one of the worst sales of 2016. After reporting another stellar result, the oil and gas services provider’s share price popped another 10% last Thursday night (it is up some 30% since we sold it).
The performance is solely due to better than expected margins. The company has slashed costs and squeezed every last cent out of its legacy contracts. Why, Gareth asked, can’t these companies be run so efficiently during the good times?
Greed is a reliable incentive. But fear is a far more powerful one. We all strive to get better. Most of us want to make money. But when we are faced with losing our job, business or savings, we suddenly realise how much more we are capable of. We start coming up with new ways of doing things that save us a lot of money.
This applies to individuals, it applies to businesses, and I think it applies to entire economies.
Recessions and productivity
Since the Bretton Woods global monetary system broke down in the early 1970s, central banks have been actively using monetary policy to tame the economic cycle. Every time growth slows, they slash interest rates in order to avoid an economic contraction. It has been mostly successful. Prior to 1970, a recession occurred roughly once every 5 years in the US. Since 1970 it has been once a decade. In Australia, of course, we have racked up 25 years and counting without an official recession.
Could this be a cause of the decline in productivity? Perhaps recessions are an important source of efficiency gains. Perhaps they are also an important source of new business formation. I know a lot of people with plans to start new businesses but giving up the security of a high-paying job has been an insurmountable hurdle. Keeping the economy afloat keeps all of these people in jobs.
I’m not for a second saying that is a bad thing. Lower productivity growth might be a trade-off worth accepting in exchange for less economic instability. But I would like to see someone test the idea.
If nothing else, it would give one more woe to the whipping boy.
I’m reading this at work on my iPad. Hence the productivity decline ! Blame Apple.
I thought Gareth was the Austrian Economist!
But goes to the antifragile point of Nassim Taleb that govenors of mechanical or natural systems can have perverse outcomes.
The frictional costs of destruction of jobs and companies and unemployment etc maybe more than compensated by phoenix rising of new jobs and companies.
I think that the governments are as guilty as the central bankers. A lot of government policies and the ever growing wave of intrusive regulations stifle competition and directly and indirectly decrease productivity.
Examples are countless. From propping up inefficient industries to restricting who, when and where can sell medicines or newspapers.
Of course, the claimed trade-off espoused by politicians and lobbyist is social stability and common good, but this stability may lead to paralysis.
You make some good points. There’s a natural human aversion to making tough decisions. Nowhere is this more prevalent than in governments. Only when we are compelled to do so are we willing to make those tough decisions.
Historically, recessions have stressed businesses, governments, and households which forces them to allocate resources more efficiently which contributes to productivity gains. I worry that without the periodic culling, we are slowly sowing the seeds of future problems. Certainly our economic system is operating below potential and that is not ideal for anyone.
I have a hypothesis that labour productivity growth in developed countries has been low because of the abundant substitutes overseas for low skilled, low cost labour. If you are a manufacturer in the U.S. and you want to lower your costs, the typical playbook for the last 30+ years has been to build a factory overseas. There’s been little incentive to become more productive with your U.S. factories/labour. This may explain some of the reason for limited real wage growth for low skilled labour. With the rise in automation, it seems unlikely that there will ever be a return to the “good old days” for the low skilled worker.
Your hypothesis about subdued wages growth in developed countries is one that I share as well. It seems to be an increasing trend that is work does not need to be physically performed n a developed country, and be performed offshore, it will be.
Automation and virtual migration is probably going to accelerate this process in the next couple of decades.
The end point seems interesting. To me it is similar to John Maynard Keynes’s paradox of thrift. All economic output is ultimately expenditure by people at the end of the value chain. Businesses might see a profit uplift by moving jobs offshore, or automating processes, but ultimately this would flow through to lower median wages in developed countries as the people increasingly displaced from the workforce find it difficult to find alternate employment.
This could start a vicious cycle in which businesses in developed countries are unable to lift prices and need to increasingly rely on discounting and cost cutting to maintain or increase profits – with the biggest bucket of costs to cut most likely being labour costs. It might be a reason why we see persistent low inflation nowadays – a structural shift in the economy which hasn’t been detected in central banker’s modelling of the economy and inflation. Lower interest rates might simply fuel the switching of labour to machinery as well and exacerbate the problem.
I think it goes to the nature of “productivity” and the make-up of modern first world economies.
In an agrarian economy you can measure productivity by crop yields, milk production per cow, wool production per sheep etc. .
In a manufacturing economy you can measure productivity by the input costs for each widget produced,
In a service economy it is much harder to measure productivity. How do you measure the productivity of a waiter, a model, a merchant banker, an artist, a fund manager, a lawyer or a politician? Other than perhaps the artist, what exactly do the others produce?
The service nature of modern developed economies makes it harder to measure productivity.
Here’s a wee comment about service based economies, reduced to absurdity for the point of illustrating the point.
Wealth comes in only three possible ways:
– agriculture – growing things on the land, using the land and the sun to turn dirt into something of value (grains, fruits, animals, etc)
– mining – digging up dirt in order that it be transformed into something of value (typically metals, gemstones don’t really count unless you consider industrial diamonds)
– transforming – manufacture by taking input goods (lumps of metal, glass, components, nuts, bolts, electronic parts, lumps of wood, etc) and transforming those into something of value (cars, iPhones, desks and chairs, and so on).
During the making something of value there are costs (input goods, fertilisers, labour); taxes (important) and finally there is a sale price. The sale price needs to cover all the input costs and taxes or the enterprise won’t survive.
Along the way the people being paid have wages (a cost to the enterprise but essential for the people) and they pay income taxes, and thus the wealth of nations is made and governments get their revenue.
Services on the other hand CHARGE people for performing some function (cutting your hair, doing your taxes, fixing your car, building a house, making and serving you a coffee).
Services have 2 important distinct parts: A business cost (which in the end is just another input cost, see above), or a charge to a person.
Those charges to persons are paid by those persons from their after-tax income. But those who receive such services income also pay income tax on it, and thus as the amount of services in an economy grows so too does the amount of tax charged on respective amounts of already-after-taxed income.
Taking this to absurdity, one can imagine a large circle of hairdressers all sitting and cutting the hair of the person in front. Once done, each turns to the person behind and pays the $20 for the haircut.
Firstly one can immediately see that this exercise created hair on the floor but no new wealth – after the haircuts, nobody was better off. But secondly, after each has paid tax they all collectively have LESS wealth than before.
This might seem a silly example but it serves to illustrate why a purely services based economy won’t do well for anyone, and won’t have wealth or growth.
In the end an economy needs to grow stuff, dig stuff up, or make stuff. Preferably a good mix of all of them. Oh guess what Australia is not doing so much of any more….
So what you’re saying is that as a country moves toward a “knowledge based” economy it creates less wealth. After all, “thinking”, “discovering”, “learning” are not “making”, “growing” or “digging” – right?
So what part of an advanced widget maker creates more wealth, the designing and developing part (service) or the assembly line?
LOL at the inside trading in DDR, could not be any more obvious. And why should the sellers with non-public information care – it’s not like ASIC is going to do anything about it.