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The Bush miracle, again ?

August 17th, 2003

In the comments thread to a recent post, Brad de Long argues against my claim that it’s appropriate to focus on multifactor productivity, pointing out

falling prices of IT have led to an *enormous* increase in the rate of capital deepening. Stagnant capital productivity and slow growth in multifactor productivity are not inconsistent with rapid growth in labor productivity if capital goods become really cheap really fast…

On reflection, I think Brad is correct at least in principle. The point he makes reflects the distinction between “embodied” productivity growth, which arises from better and cheaper machines, and “disembodied” productivity growth, which is the residual captured in multifactor productivity calculations. The remaining issue is how the numbers work out

The BLS estimates that the rental price for capital services has been fell by about 2 per cent per year from 1995 to 2000, so if the GDP deflator was rising by around 1 per cent, that makes a real price decline of 3 per cent. This seems plausible – Sichel estimates that the real cost of computing services is declining by about 8 per cent a year (17 per cent for hardware, 8 per cent for software, 0 per cent for computing services labor), computing services are still well under half of all capital services, and the real decline for other capital services is modest.

Now for a back of the envelope exercise which I think works out OK for a simple Cobb-Douglas technology with coefficients of two-thirds for labor and one-third for capital. To keep the capital share of national income constant at one third, you would want real capital stock per hour worked to grow at 4.5 per cent annually yielding growth in output per hour of 1.5 per cent per year. If you add in MFP and trend labor composition growth of 1 per cent, you get labor productivity growth of 2.5 per cent per year, which fits the late 90s almost exactly, as does the implied decline in output per unit of capital of 1.0 per cent per year. Add in trend labor force growth of 1 per cent per year, assume constant hours per worker, and the growth rate required to maintain a stable unemployment rate is 3.5 per cent.

All this is exactly in agreement with Brad’s own analysis of the historical average performance from 1960 to 2001, and the assumption that the period 1995-2000 was about average, not as good as the 1960s, but a lot better than the 1980s. The main difference from the average is that the relationship between embodied and disembodied productivity growth has switched. For the entire period, embodied growth is about 1 per cent and disembodied (TFP + composition) about 1.5 per cent.

The big question is how to interpret the experience from 2001 onwards with the unprecedently rapid decline in hours, and the corresponding rise in measured productivity, reaching a growth rate of 4 per cent per hour. In a previous post, I argued that labor composition effects such as the declining employment of teenagers could account for as much as 1 percentage point. Taking account of the fact that labor composition changes were already having a modest positive effect, I’d prefer a net additional impact of around 0.75 per cent. Now if we assume that growth in the capital stock did not decline by as much as growth in hours worked, yielding, say an extra 2.25 percentage points of capital deepening, we can get an extra 0.75 per cent productivity growth from this source. The total extra productivity growth induced by declining hours, then gives extra annual growth of 1.5 percentage points. Added to the ‘underlying’ growth rate of 2.5 per cent, this gives 4 per cent, which matches Brad’s graph exactly.

On the basis of this preliminary analysis, I don’t see any need to suppose that there has been an upward shift in underlying productivity growth since 2000. What remains puzzling is the macroeconomic behavior of the US economy during the bubble and bust.

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  1. August 17th, 2003 at 19:08 | #1

    PrQ acts as the economic superego of the web, by asking the taboo question on the real economy:

    What remains puzzling is the macroeconomic behavior of the US economy during the bubble and bust.

    Standard macro-eco would predict that, given the scale of the capital over-investment and corresponding financial values collapse, the US should suffer a large & lengthy recession.
    But that dog has not really barked yet.
    It seems that US real economy is being propped up:
    On the supply side by a combo of high:
    labour market flexibility
    IT capital productivity
    On the demand side by: wealth effects of low interest rate/high asset values on consumer spending.
    This underlying industrial strength would explain the other unsolved mystery of the US business cycle: the continuing resilience of US financial market asset values.
    If US/RoW demand for US consumer goods picks up then US corporate earnings will really jump, as all extra revenue will be straight onto the bottom line. This likely earnings growth is perhaps what bullish markets are factoring in, given their masssive post-Iraq recovery.

    All this points to there being some truth to the notion of New Economy:
    institutional: flexible free & open factor markets
    industrial: hi-tech knowledge products based on bootstrapping info-tech learning curve
    economic: higher than average (2.5%) speed limit-breaking rates of economic growth
    financial: increases in corporate earnings quickly factored into bullish finance-equity markets
    Perhaps it is time to start believing in the New Economy miracle.

  2. jp
    August 18th, 2003 at 04:12 | #2

    The four points that JS highlights above are indicative of a broader hypothesis: As market capitalism becomes a global network, ever bigger and ever less without a centre and so seemingly more ‘smooth’, its dynamics become more puzzling. A network theorist would note that there may still exist components supported by functional boundaries making for densely connected clusters or ensembles of interaction (e.g., A. Barabasi, ‘Linked: the new science of networks’ 2002). These are important because productive economic activity is concentrated in these densely connected ensembles (e.g. firms). But they are ultimately a fluid, and the mechanism that reshapes this is changes in connectivity.

    The growth dynamics of US economy are those of a system inducting and absorbing a massive incident increase in its connective structure. The connective density of the US economy to the global eocnomty has been growing and we are now begining to fully appreciate how this effects its dynamics. The US has become a hub, both figuratively and literally, but this has nothing to do with Bush (or Howard, or Blair, or bin Laden, etc). The network structure has become much denser of recent, and it seems that the shock waves are still rippling through asset markets, in particular.

    All of JS’s points involve changes in the connective structure of the economic system. Networks tend to exhibit percolation thresholds, i.e. points of connectivity (interaction) at which the behaviour of the system changes. There are upper and lower bounds to this. But in general, just as most real economic systems are inside their production possibility frontiers, so too most real economic systems are inside their connective possibility frontiers. New connections tend to add value as a statistical evolutionary process.

    The US is going through a phase of growth of incident connective structure, and which is further driving more complex structure internally that is then re-entrant (re-entrant in the sense of A. Damasio’s neurological models) on that same structure.

    We are living through a phase of massive uncertainty driven by uncertain connective structural implications (and hence the reflux to investment in things you can see and touch and isolate (houses this time, not gold)) on the back of a massive growth in the degrees of freedom available to a growing global cluster of economic interactions. One hundred years ago the percolating cluster of economic interactions was much less than one hundred million agents. Now, arguably, it is several orders of magnitude above that. The interaction structure has not scaled monotonically.

    As JQ points out in the lead to this thread, the behaviour of the US macroeconomy of recent is a theoretical puzzle: it is not clear in what aspect this aperiodic behaviour lies.

    Structure effects dynamics, and perhaps now we are already in the narrow of the rapids. Perhaps the camp leaders of our canoe, Bush, Howard or otherwise, monarchist or republican, may be far less significant than a clear sense of where we actually are, dynamically speaking, in terms of our changing interaction structure, which we know very little about. And so that is why there is uncertainty…

  3. August 18th, 2003 at 12:45 | #3

    JP seems to be coming from a Santa Fe systemic chaos/complexity/connectivity/catastrophe (C4)perspective. Somehow modern C4 systems are much more self-organised, interactive and non-linear dynamic than pre-C4 systems.
    This makes them more stable for a given period but highly unstable between periods ie subject to critical phase transitions to new forms of:
    complex spontaneous order (eg New Economy)
    catastrophic disorder (eg power blackouts)
    The trouble with this form of analysis is that it seems to be restating in high-falutin terms, what we already know in day to day life.
    Less high concept, more hard data please.

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