Even more optimistic thoughts about productivity growth, labour market flexibility and Secular Stagnation
David Glasner has an excellent new blog post on why he is fairly optimistic on the outlook for productivity and the risk of "Secular Stagnation" in the US. The post contrast another blog post from Scott Sumner who argues the pessimistic case on US productivity. My own position on US productivity growth in the US since 2008 is very much in line with David's take. Here is how David explains why US productivity growth has been fairly slow.
I don’t deny that secular stagnation is a reasonable inference to be drawn from the persistently low increases in labor productivity during this recovery, but it does seem to me that a less depressing, though perhaps partial, explanation for low productivity growth may be available. My suggestion is that the 2008-09 downturn was associated with major sectoral shifts that caused an unusually large reallocation of labor from industries like construction and finance to other industries so that an unusually large number of workers have had to find new jobs doing work different from what they were doing previously. In many recessions, laid-off workers are either re-employed at their old jobs or find new jobs doing basically the same work that they had been doing at their old jobs. When workers transfer from one job to another similar job, there is little reason to expect a decline in their productivity after they are re-employed, but when workers are re-employed doing something very different from what they did before, a significant drop in their productivity in their new jobs is likely, though there may instances when, as workers gain new skills and experience in their new jobs, their productivity will rise rapidly.I very much agree with this assessment on why US labour productivity growth has been relatively weak. In fact one can argue that this reflect that the US labour market has become relatively more flexible. Simplified one can say those who have lost their well-paid high-productivity job in the financial services sector have now chosen to take low-paid, low-productivity "McJobs" rather than becoming unemployed. I believe a similar argument also has some validity in relationship to the even weaker growth in UK productivity since 2008. Productivity - less bad than the general perception While think that there might be a labour market flexibility-explanation for the modest productivity growth in the US since 2008 I also think that it is useful to look a bit close on labour productivity compared to previous US recoveries. What I have done is to look at the development in labour productivity (defined as real GDP/total non-farm employment) during all the recoveries in the US economy since the 1940s. The graph below shows the level of labour productivity in the US during the recent recovery compared to the average development in productivity in all of the post-WWII recoveries. In each recovery the start-quarter is the official last quarter of recession. The blue line is the development in productivity during the most recent recovery (starting in June 2009). The red dotted line is the simple average of the level of labour productivity during all the recoveries since the 1940s. The four thinner red lines are +/- 1 and 2 standard deviation around the average. Based on this we can draw a couple of important conclusion. First. the development in productivity during the first two years (2009-2011) was completely in line with the historical average - in fact if anything slight better than the historical norm. Second, even though productivity growth has been weaker than "normal" - particularly since 2011-12 - we cannot say that this is statically significant in anyway as productivity during the recent recovery has stayed within both the 1 and the 2 standard deviation band. Third and more speculative - there might be an explanation for the difference in productivity in growth in the first two years of recovery and the following years. Hence, during 2009-10 the recovery in employment in the US was primarily driven by a recovery in aggregate demand (nominal GDP). However, since 2010-11 the Federal Reserve has just kept NGDP growth around 4% growth. This has provided "demand stability", but it essentially has not been what have driven employment growth - rather employment growth since 2010-11 has been driven by the fact that US wage growth has been significantly slower than NGDP growth. Said in another way most of the increase employment in the later part of the recovery has been driven by an adjustment in wage growth to the new slower "equilibrium NGDP growth rate". This essentially the labour market supply curve shifting rightwards as expectations adjusted the lower than earlier (during the Great Moderation) NGDP growth rate. Sumner's musical chairs and the smaller-than-normal chairs Scott Sumner has popularized what he has called the musical chairs model of the labour market. In Scott's model the unemployment rate is essentially determined by the ratio between NGDP growth and growth in nominal hourly wages - or said in another way between demand and supply conditions on the labour market. My hypothesis is that we can use the musical chair model - at least indirectly - to understand what has been going on with productivity in the US since 2009. The graph below shows the development in NGDP growth and nominal hourly earnings in the US.