Behind the curve. What if low wages are what's keeping productivity increases low

[Póg mo 1,749]

There’s something unsettling about finding yourself at home in bed, under the duvet, Pringles in one hand, remote in the other, binge-watching ‘House of Cards’.

As you try to come to terms with where you have ended up, can you take some comfort in the fact that a significant chunk of the reasonably well-educated bourgeoisie is also addicted? Are we, at all hours of the night, gorging on Netflix, checking emails, responding to Whatsapp groups, booking an Uber or buying something on Amazon?

Is technology taking over our world and what does it mean for the global economy and for our way of thinking about the world?

In this update, let’s tease out some of the connections – not always apparent – between technological innovation, low productivity, wage deflation and the conundrum faced by central banks everywhere. The central banks’ dilemma is that they are itching to raise rates but finding no reason to do so.

Economics is constantly evolving

At the beginning of every year, when my students sit down in front of me at Trinity College in Dublin, I can’t stress enough the importance of not only what they’ll learn in textbooks, but what they see happening in the world around them. As the world changes, our understanding of the economy should change too. But sometimes it doesn’t.

Too regularly, economists – and in particular policymakers – display a form of ‘groupthink’ and seem wedded to old models that appear impervious to the changes that are taking place in the real world.

Groupthink, when wrong, can lead to huge policy errors and have enormous unnecessary repercussions. As the global economy is growing and unemployment is falling, the default position of central bankers, from the Fed to the BoE to the ECB, is that inflation has to be around the corner.

But, what if it’s not?

What if policymakers in their ivory towers wedded to old ideas do not appreciate that technological change and the likes of Whatsapp, Uber, Amazon and Netflix, are driving deflation not inflation?

Furthermore, the data suggest that wages are not rising and productivity is on the floor. How do we explain this at a time when productivity should be rising and wages too?

 

 

https://woodfordfunds.com/words/insights/behind-the-curve/

[IAMX 3,055]

I think you need to steer the discussion because this covers way too many different subjects.

[OriZ 3,157]

Yup, I have been saying that for many years - everybody thought the Fed was going to cause runaway inflation but the greatest risk, still, even after 9 years of intervention is deflation so I agree with that. Considering employment growth is only expected to contribute 0.3% annually to GDP over the next 7 years, any additional economic expansion will have to come from productivity growth. Barring any increase in the unemployment rate(and we all know it's going to happen considering we're close to full employment already) - with current productivity trends continuing would produce real GDP growth over the coming 7 year period of between 0.9% and 1.5% annually. I definitely think we might see some pickup in productivity over the coming decade, but likely not till after a recession. In the last few decades, earnings growth has outpaced revenue growth because of a profit margin expansion, which was closely tied to real wage growth not keeping pace even with the weak rate of productivity growth.

 

And here's the thing with profit margins that are extremely elevated now and I don't believe it can continue: If growth strengthens in a tightening labor market, labor costs will become an increasing share of output value thus suppressing margins. If growth weakens, productivity will slow and raise unit labor costs by contracting the denominator. Even if productivity was restored to pre-2000 averages, the expectation would still be for GDP as high as only 2.3% per year. Neither the prospects for economic growth nor the prospects for earnings expansion are likely to benefit from the same dynamics that they enjoyed starting from a 10% unemployment rate in 2009. What “Main Street” perceives as a weak economy has far less to do with jobs per se than with the growing income disparities(produced by low real wage growth that has its mirror image in high profit margins), along with declining contributions to GDP growth from population growth and productivity. The arithmetic of GDP growth isn’t going to change, but with a tightening labor market, the skewed division of income between wages and profits has already quietly started to normalize.

 

With expectations for somewhat faster productivity growth comes optimism that real GDP growth will average close to 2% annually over the coming decade. I don't disagree, however it’s important to distinguish this average trend from the cyclical growth rates that are likely over shorter time frames. Right now we are facing the prospect of sustained slowing or outright contraction of economic activity over the next several years. Over the long term, the growth of productivity is driven by the growth of domestic investment. This is why Trump's protectionist policies could actually harm growth, as growth in domestic investment is also associated with deterioration in the trade deficit. This is a strong regularity across history: the quickest way to “improve” the US trade balance is to torpedo gross domestic investment, and the quickest way to “worsen” the trade balance is to enjoy a boom in gross domestic investment. 

 

Per Hussman:

From a cyclical perspective, the problem is that once the trade balance is already at a significant deficit, there is little remaining slack for rapid expansion in either gross domestic investment or, by extension, productivity growth. Periods of rapid economic growth typically emerge from points of high unemployment - not when unemployment is already quite low. Likewise, periods of rapid economic growth typically emerge from points where the trade balance(exports - imports) is elevated as a share of GDP - not when it is already at a steep deficit.

Because of these dynamics, US economic growth tends to mirror(with a lag of about 8 quarters) the profile of the US trade balance as can be seen below:

 

 

I also want to add another brilliant piece I just read yesterday to this discussion:

 

Today is the launch of the online version of my Economics 1 course (and namesake of this Blog and my Twitter handle) on the Principles of Economics for summer 2017. This year is also the tenth anniversary of the start of the Global Financial Crisis and the Great Recession which began in 2007.

During these ten years there has been great deal of hand-wringing among economists and others about the subject of Economics. This is an important debate, and the different positions deserve to be covered in the basic economics course.

 

As early as 2009, a cover of The Economist magazine showed a book titled “Modern Economic Theory” melting into a puddle to illustrate what the writers viewed as the problem with economics. It was the most talked about issue of the year.

Some economists have been calling for a complete redo of economics—or for a return to a version of the subject popular decades ago. They say that economics failed to prevent the Great Recession and the Global Financial Crisis or even led to them. Many of these economists argued for a change government policy, saying that John Maynard Keynes was right and Milton Friedman was wrong.

 

Paul Samuelson spoke this way in an interview in the New Perspectives Quarterly in 2009 saying, “today we see how utterly mistaken was the Milton Friedman notion that a market system can regulate itself… This prevailing ideology of the last few decades has now been reversed…I wish Friedman were still alive so he could witness how his extremism led to the defeat of his own ideas”.

Paul Krugman, in a piece in the New York Times Magazine in 2009, also faulted modern economics for bringing on the crisis. He said it focused too much on beauty over practicality and did not recognize the need for more government intervention to prevent and cure the crisis. His fix was to add more psychology to economics or to build better models of credit.

 

And over the years the debate has continued. Last year Thomas Sargent, in commenting on a Handbook by macroeconomists said the “collection belies uninformed critics who assert that modern macroeconomics was wrong footed by the 2007-2009 financial crisis….both  before and after that crisis, working  macroeconomists had rolled up their sleeves to study how financial frictions, incentive problems, incomplete markets, interactions among monetary, fiscal, regulatory, and bailout policies, and a host of other issues affect prices and quantities and good economic policies.”

 

But also last year Paul Romer, now chief economist at the World Bank, wrote a widely discussed piece called “The Trouble with Macroeconomics.” Then Ricardo Reis of the London School of Economics wrote a paper more supportive of economics with the title “Is something really wrong with macroeconomics?” My colleague John Cochrane commented positively on the views of Reis, and Noah Smith explained in a Bloomberg Viewcolumn why “So Many Critics of Economics Miss What it Gets Right”

 

So the debate moves on. My view, throughout this period, has been that the Great Recession and the Global Financial Crisis do not provide evidence of a failure of economics. Rather theses events vindicate the theory. The research I have done, here for example for the Fed’s Jackson Hole Conference in 2007, points instead to a deviation of economic policy from the type of policy recommended by economic principles–a deviation from the type of policy that was responsible for the remarkably good economic performance in the two decades before the crisis. Economists call this earlier period the Long Boom or the Great Moderation because of the remarkably long expansions and short shallow recessions. In other words, the crisis did not occur because economic theory went wrong. It occurred because policy went wrong.

 

https://economicsone.com/2017/07/17/debate-over-the-very-principles-of-economics/

 

 

[IAMX 3,055]

lol Krugman faults modern economics while preaching debt monetization 

 

I swear that guy needs to have his degree revoked 

[OriZ 3,157]

1 hour ago, IAMX said:

lol Krugman faults modern economics while preaching debt monetization 

 

I swear that guy needs to have his degree revoked 

And the nobel prize...

 

The guy is a complete loon. I have never seen him say anything that makes sense.

[Póg mo 1,749]

3 hours ago, OriZ said:

And the nobel prize...

 

The guy is a complete loon. I have never seen him say anything that makes sense.

Funny how you and PK are in agreement about the lack of inflation resulting from low interest rates, or where PK also says he is against trade barriers, but do go on. 

[IAMX 3,055]

1 hour ago, Póg mo said:

Funny how you and PK are in agreement about the lack of inflation resulting from low interest rates, or where PK also says he is against trade barriers, but do go on. 

Give this man a degree in economics.

[OriZ 3,157]

2 hours ago, Póg mo said:

Funny how you and PK are in agreement about the lack of inflation resulting from low interest rates, or where PK also says he is against trade barriers, but do go on. 

Ok let me rephrase that - he'll say something I'll sort of agree with(usually his reasons are different than mine though) out of 10 things in the same article. But as a whole, still doesn't make sense. You can't just take bits and pieces and call it an agreement - just because I don't think low interest rates inevitably cause inflation, doesn't mean I agree with the policy, whereas he does. So again, taken as a whole, his opinions just don't make sense to me. Low interest rates for a very long time distort financial markets and sow the seeds for the next crisis. And then when the crisis hits they treat it with what? You guessed right. Low interest rates!

Edited July 19, 2017 by OriZ

[The Nature Boy 7,659]

5 hours ago, OriZ said:

And the nobel prize...

 

The guy is a complete loon. I have never seen him say anything that makes sense.

Nobel prize means nothing. It's a joke now