Sunday, February 23, 2014

Ryan Avent's Meme of Troubles

"The productivity puzzle that began in the 1970s persists..." writes R.A. at The Economist. I like that because it takes us back to the 1970s. It takes the problem back to the 1970s. That's important. If we have a problem that started in the 1970s, we can't fix it by looking at what happened since 2008, or in the 2000s, or even in the 1980s. We have to look at the 1970s, when the problem developed. We have to look back before the 1970s, when the problem was developing and we hadn't yet noticed.

"...thanks to the apparent fizzle in productivity growth since the internet boomlet of 1996-2004..." R.A. adds, as if we all know it was the internet that temporarily solved the problem. Nice to know that, isn't it? It's nice to know things. Too bad we know all this before we even start investigating the problem. Eh, human nature: Shoot first, ask questions later.

"...and despite what looks to many like an ongoing acceleration in technological discovery." R.A. concludes his thought by pointing out something that ought to invalidate the "internet boomlet" explanation. He doesn't pursue that, but instead goes back to puzzles, and fleshes out a whole list:

There are puzzles of wage stagnation and falling labour-force participation. There are savings glut puzzles and secular stagnation puzzles. The common thread linking the puzzles is that they almost always mean trouble of one sort or another. Many stories have been presented to explain some of these phenomena (and others, as well, like rising inequality and the striking emergence of jobless recoveries)...

R.A. wants to "tie these stories together into ... a broader theory of troubles."

"The immediate motivation for the argument presented here," he writes, "is work done on the diverging fortunes of the British and American economies over the past six years." Over the past six years, he says. So much for the 1970s.

I don't have to read any more to know that R.A. is not attempting to discover the root of the problem. I already know he is looking only at results of what has become a 40-year-old problem. I'm sure he will make a good story of it, and I'm sure he will convince some people. But it will be all an investigation of results, and at best an attempt to solve results rather than to uncover and solve the problem.

R.A. then begins to make the key points of his argument. "Since the early 1980s, labour markets have polarised or 'hollowed out'", he writes. And "Since the early 1980s, polarisation has occurred almost entirely during recessions."

But these are the early responses to the problem that developed in made itself obvious in the 1970s -- the problem that was doubtless developing in the 1960s.

Then he makes a most interesting observation:
The jobless recoveries of the past generation have been characterised by a change in the cyclical behaviour of productivity.
Prior to the mid-1980s both output and productivity growth tended to fall relative to trend in recessions and rise relative to trend in expansions. Beginning with the recovery from the 1981-2 recession, however, the behaviour of productivity flipped. It has since risen relative to trend in recessions and fallen relative to trend in expansions.

Graph #1
That catches my eye because the change R.A. describes follows immediately after the change in the trend of interest rates in 1981.

Quite a coincidence. Or rather, quite a striking chronological similarity.

The things that were different since 1981, including the cyclical behavior of productivity and the trend of interest rates, must be considered together, and considered as a description of the key change that occurred in 1981 when Paul Volcker broke the forces driving interest rates.

I do not identify the key change. I only emphasize that we must identify it. But Ryan Avent does neither. He moves instead to conclusion:

Taken together, these observations imply that in the presence of moderate inflation, real wages will be more flexible and productivity will flip back to falling, rather than rising, amid weak demand. That brings us back to the motivating example of the Britain versus America comparison, where that implication seems to have verified.

Verified, he says.

Me? I'm talking about gathering up things that changed in 1981 and considering them. I'm talking about pushing the envelope back to 1960 to seek preliminary indications of the cause of the "productivity puzzle that began in the 1970s".

R.A.? He's confirming things already. He's verifying things by looking over "the past six years" and by plucking observations out of the mid-1980s when people were already responding to the puzzle of the 1970s and to the fine handicraft of Paul Volcker.

Verified? Don't even think about it.

Avent then draws "further lessons from this". I love it. Jump to conclusions, then build on them right away. Don't give people time to mull them over. Build on them, tie them into your story, interpret them in the way that furthers your story. Make them part of your meme.


These facts describe a particular relationship between technological change and macroeconomic policy. Low inflation in the era after the Volcker recessions significantly reduced the flexibility of real wages. As a result, employers faced pressure to raise employee productivity at times of weak demand, in order to reduce the effective real wage of existing workers.

See? I told you it'd be a good story. R.A. goes on from there, to build what even he calls a story. "The key dynamic in this story," he writes, "is steady improvement in technological progress."

And it is a well-told tale. Everything fits. Everything comes together and it all makes sense. Why? Because in the economy, everything affects everything and it is all related. It is not difficult to pick a starting point and develop a story in which everything is an outgrowth of your particular starting-point. It's not difficult, at all. That's how we get so many contradictory versions of how the economy works and what's wrong with it.

It's like solving a math problem. If you start in the wrong place, you can do everything else right and still get the wrong answer. Ryan Avent starts in the wrong place. He doesn't go back to the time before the problem first arose.

The problem that arose in the 1960s was the growing accumulation of private debt. Growing debt increased costs for those who owed it and increased incomes for those who owned it. These initial costs stand as the force underlying the rise of the Great Inflation in the mid-1960s.

But the economy was still good in those years. Not a lot of "toxic assets" back then. The owners of debt made reliable income from it. It was more appealing than having to work for your income, evidently, as finance grew far faster than output:

Graph #2: Total Financial Assets of Financial Business (blue) and GDP (red)
See also Total Financial Assets of Financial Business as a Multiple of GDP at FRED

Graph #3: Doug Henwood's Graph
In the good economy, the rising income to of finance ate into the profits of the productive sector, making financial investment increasingly more appealing than productive investment. Economic growth was gradually undermined by this change. Meanwhile, the rising cost of finance ate into consumer income and caused atrophy of demand. At The Current Moment, the authors show Doug Henwood's graph and observe that "since the late 1960s, workers in general have been keeping hold of less and less of what they produce."

Income was redirected away from wages, and into the financial sector. This is clearly evidenced in corporate cost trends:

Graph #4: Employee Compensation (blue) and Business Interest Cost (red) as Percent of their Sum
The graph shows income shifting out of wages and into finance. This change had a depressing effect on production, on output, and on demand.

By the 1980s policies were being put in place -- supply side policies, intended to boost supply side income. These policies worked largely by changing the distribution of income. Today's income inequality is a result of policies designed to boost economic growth by creating supply side advantages.

But the original problem goes back to the 1950s and 1960s, the gradual, relentless increase of financial income relative to wages and productive-sector profit.


Jazzbumpa said...

But the original problem goes back to the 1950s and 1960s, the gradual, relentless increase of financial income relative to wages and productive-sector profit.

I agree totally. Also th previous paragraph.

But --

The problem that arose in the 1960s was the growing accumulation of private debt. Growing debt increased costs for those who owed it and increased incomes for those who owned it. These initial costs stand as the force underlying the rise of the Great Inflation in the mid-1960s.

This is a testable hypothesis. The data does not support it.


The Arthurian said...

I like your post, Jazz. The only problem I have is with your ambiguous terminology. The debt component in your "CPI vs Debt Growth" graphs is "YoY Change" in the debt of households and nonprofits. YoY Change is the annual increase in debt, or "debt growth", so I have no problem here.

But you are looking at the annual increase in debt. I am talking about "the growing accumulation of private debt". What you call debt growth, I call "new use of credit" so as to distinguish the boost it provides from the drag created by accumulating debt.

On a separate note... It is not altogether unreasonable to say that once it begins, inflation can become self-perpetuating. That is the common argument used to explain the Great Inflation.

It explains why it took so long to stop that inflation. But it does not explain how that inflation got started.

I claim that both personal income and non-financial profits were squeezed by the costs that produced growing financial profits, and that this squeeze was the originating force that gave rise to that inflation in the first place.