Productivity – cutting both ways

Far from being a cure-all, productivity gains are instead cutting into the number of jobs

Higher productivity seems like the answer to all of our economic woes but being more productive is not all good.  Doing more with less is a way of making us wealthier by getting more out of the limited resources available.  Improvements in productivity often thus translate into more profits or lower prices (or both).  But there is also a nasty side in that one of the resources that can be done away with is workers.  Trends such as greater globalization and improvements to technology have resulted in many (well paying) jobs being put to the chop and we should not be expecting any respite soon.

Doing more with less

Economics is a discipline which is based on the notion of scarce resources.  It is no surprise then that economists rave about how improvements to productivity are the key to prosperity.  Any business that can produce the same products using fewer inputs is bound to do well.  Being more productive as a worker is also opens up the way for the opportunity to demand higher wages.  Any gains from higher productivity are split between companies, employees, and consumers but it is not always the case that everyone gets a share.

My favourite example of productivity gains where everyone got their cut was Henry Ford and the motorcar.  Ford did not invent the automobile or the assembly line but he did figure out a way of manufacturing cars cheaply.  The continued existence of the Ford Motor Company is testament to how much he and his family have thrived.  On top of this, workers at the firm also benefited from the new jobs that were created as well as the higher wages on offer.  Cars also became available to many more people thanks to the mass production of the Model T resulting in a lower price tag.

Suffering from cut backs

The example of Henry Ford and the Model T shows how more can be produced cheaply using more workers.  But this is only a viable way of making money when there is a rapidly expanding consumer market and an appetite for more and more goods.  This seemingly came to an end in the richer countries when most households became wealthy enough to buy the basics such as a car, a fridge, and a TV.  Without being able to tap into economies of scale by producing more and more, the emphasis has since shifted to producing goods at the lowest cost. 

One of the main avenues for cutting costs has been outsourcing manufacturing and some services to countries where wages are lower.  Computers and the Internet have also helped companies save money by better optimising their operations and reducing the need for some clerical work.  Companies have obviously benefited from this and we have as consumers (due to lower prices) but not as workers.  There is no modern-day version of the Model T that might provide a new source of lucrative job opportunities.  Instead we spend our money on services (eating out or going away on holiday) or goods where much of the value is in design rather than the goods themselves (such as clothing or electronic gadgets).

Cut yourself free

The challenge for developed countries is to create more high paying jobs for its educated workforce.  Instead, the opposite seems to be happening and the economic recovery after the global financial crisis has been characterized by a proliferation of jobs with low pay.  Higher unemployment allowed companies to hire workers on the cheap and this has dulled incentives for business investment.  It is easier to get things done using cheap labour than spending money on making your current workers more productive. 

Unemployment in countries such as the US and the UK has fallen but this has yet to translate into significantly higher wages.  Neither is a rapid improvement likely as companies are still timid about investing due to the weak momentum of the economic recovery.  Government policy is also a hindrance due to the focus on austerity measures rather than taking advantage of low interest rates to invest.  

The only way out for beleaguered workers seems to be setting up their own business which has become increasingly more popular.  The jump in entrepreneurship may be one of the few silver linings as people cut themselves free to become their own boss and to have productivity gains there for the taking.

Nasty Breakup from Forward Guidance

Central banks have been led astray by the policy of forward guidance and it is time to move on

There has been a big breakup in the world of economics just before Valentine’s Day.  Central banks in the US and the UK had been wed to the concept of forward guidance.  This policy involves keeping interest rates low will have greater potency when combined with an outline of how long the policy will remain in place.  With the impact of low interest rates on the wane, central banks in the US and the UK were courted by the idea of forward guidance as a way to eke more out of current policies.  Yet both the Federal Reserve and Bank of England have been caught with their pants down due to the failure of forward guidance to deliver an economic boost.  The falling out has been made worse by debilitating issues with policy execution.

Seemed like a good idea at the time

The Federal Reserve slashed interest rates to 0.25% in December 2008 while the Bank of England pruned UK interest rates back to 0.5%.  In the face of the harshest recession in a generation, this normally dependable form of monetary stimulus failed to have much of an effect.  Continued weak economic growth spurred on a search for something extra and resulted in central banks delving into more unconventional measures.  Quantitative easing (buying bonds with newly printed money) is one example of such measures, forward guidance being another.

It was thought that forward guidance would act as a means to encourage economic growth as low interest rates were not having much of an effect on borrowing by themselves.  The hope was that a pledge that rates would be kept low for at least a few years would be the catalyst that would kick-start lending.  However, the assumption that there was a pent up demand for loans was wrong (as Your Neighbourhood Economist thought it might be). 

Bad idea made worse by shoddy execution

If the thinking behind forward guidance was not the best, the implementation was worse.  Both the Federal Reserve and the Bank of England based the forward guidance on the unemployment rate.  Unemployment was seen as a reliable yardstick of economic performance so the two central banks used it as a marker for changes in policy.  This later became a stumbling block when the number of people out of work declined faster than expected catching out many others along with the central banks.

Having to readjust the policy of forward guidance has been a PR disaster for central banks for whom reputation is key to influencing the financial markets and achieving their goals.  The Bank of England recently explicitly dropped the link between interest rates and unemployment and the Federal Reserve is sure to follow suit.  The necessity for central banks to assuage concerns that interest rates may rise defeats the whole purpose of forward guidance in the first place.

The Bank of England has instead stated that it will rely on a wider range of economic data.  Despite protestations by Bank of England governor Mark Carney that forward guidance is working, the new policy is too vague to act as any guide to the future of interest rates.  The reworking of forward guidance has failed to find any love from the markets.  Expectations that the Bank of England would not be faithful and would hike interest rates sooner rather than later resulted in the value of the UK currency jumping following the statements by Carney.  The saga over forward guidance has left central banks wondering what went wrong but it is time to get out and start afresh. 

The Productivity Puzzle and the Rise of the Self-Employed

Economists are struggling to explain why labour productivity is so low but Your Neighbourhood Economist could be part of the underlying reason

Puzzles can be fun but also frustrating if a solution proves elusive.  Such is the case with the “productivity puzzle” which is a phenomenon economists are having a tough time explaining.  Productivity of workers measured in output per worker has fallen following the global financial crisis and has remained weak.  The lack of an explanation for this is even more irritating as growth in productivity is one of the key factors in pushing up wages and generating higher levels of wealth.  But this dilemma may not be worth all of the worry.

What is so puzzling?

There are a number of pieces to this puzzle which are not fitting together.  The first is that companies are not investing as much.  This in itself is difficult to explain at a time when interest rates are at record lows and profitability for many companies is high.  One reason typically given is that firms are reluctant to risk money on long-term bets as the future is clouded with uncertainty.  Banks have also cut off funding to many smaller up-and-coming businesses who want to expand.  Others have pointed the finger at companies paying their executives with bonuses which prioritise rising share prices rather than investment for the future.

The next part of the riddle is falling unemployment.  A typical recession involves companies taking the opportunity to trim back their workforces.  This results in a jump in productivity as similar amounts of work are carried out by fewer workers.  Yet almost the opposite has proven true over the past few years.  Unemployment has not been as severe as in the past and the number of people out looking for work in countries such as the US and the UK is already falling.

This enigma appears even stranger when considering that unemployment in the UK has fallen to a four-year low of 7.1% while real GDP is still less than in 2008.  Companies seem to be holding onto their workers and hiring more staff instead of buying new equipment or upgrading their offices.  This may be a strategy to deal with an uncertain future (which would be temporary).  Alternatively, it could be a part of a larger shift in the way that business is done.

A reason not to worry

One of the key missing pieces could be technological change shaping new forms of work.  The Internet, along with innovations such as cloud computing, has brought down start-up costs for businesses.  Running a business these days can require little more than a laptop.  This combined with a dearth of decent jobs has seen a dramatic rise in the number of self-employed in the UK (including Your Neighbourhood Economist).

The self-employed are apt to rely mostly on manpower with little need for investment.  Output from operations with just a few workers is likely to be low or else others would have already taken advantage of such business opportunities.  Examples might include freelance web designers or landscape gardeners willing to live off sporadic work while enjoying extra spare time.

This is still not likely to be sufficient to entirely account for the low productivity that is vexing economists.  It is true that business is changing on many levels as people find new ways of harnessing the Internet and economists (including yours truly) are still grappling with what it all means.  However, if the solution involves making work less of a burden and more days working from home, it need not be so troubling after all.

US Jobs Data Puzzle

I once worked at a financial news service in Tokyo following the stock market in Japan and there were always certain bits of data that investors would watch out for.  One of these was the US non-farm payroll data which is released on the first Friday of every month and represents the number of jobs added or lost in the U.S. economy in the previous month.

This data was important to many firms not only in Japan but in much of Asia and elsewhere because strong growth in jobs would signal that consumers in the U.S. would be able to keep buying the goods these firms wanted to export to the U.S.  While American consumers are not the drivers of the global economy that they once were (which is a completely different topic on its own), I thought I would take a look at the jobs figures for October and see what insights we could gain from them.

The data shows that around 80,000 jobs were added to the U.S. economy in October which helped to nudge the unemployment rate down from 9.1% to 9.0%.  While the increase in jobs is positive, the jobs created in October are seen as insufficient in terms of making up for the jobs lost during the recession as shown by the graph (from the Financial Times website).  It is estimated that 6.6 million net jobs were lost in the U.S. during the past recession, and on top of this, that there are 100,000 new entrants to the job market every month.  As such, many economists believe that 200,000 jobs are necessary to make significant reductions in unemployment.

While a weak recovery in the U.S. economy is a major factor why unemployment remains so high, it is not the only issue.  The U.S. economy is in the midst of a massive shift of resources from the manufacturing sector to providing services such as health care, education, and business services such as those offered by lawyers and accountants.  These changes cause problems as workers have to move from sectors which are in decline to the expanding industries where the new jobs are being created but which may require completely different skills.  Therefore, some of the unemployment in the U.S. is cyclical unemployment which is caused by there being less work available.  But, there is also structural unemployment which is a mismatch between demand for certain skills from firms and the actual skills that workers have. 

The concept of structural unemployment helps explain a strange occurrence in the U.S. labour market.  A recent survey showed that the number of vacant jobs in the U.S. was 3.4 million in September which is the highest in two years.  One reason for this is that workers no longer have the skills that companies are looking for.  Another reason is to do with the housing market.  The slump in house prices means that around one quarter of all mortgage borrowers in the U.S. owe more to the bank than their house is worth.  The result being that people in this predicament are less likely to sell their home to move to take a job elsewhere.

Apart from the immediate hardships that unemployment causes, long spells of unemployment often result in skills that workers have becoming out-dated or people losing contact with the job market and not returning.  This may slow the recovery in the U.S. economy as there will not be the right type of workers for the jobs that firms want to fill and the workers will tend to be less productive than they otherwise would have been.  The problem may be all the greater due to the lack of resources provided to educate and retrain workers and could be one factor that could weaken the dominant economic position of the U.S.