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.

Let's not (Christmas) party like it's 2007

The heady days leading to the global financial crisis were never meant to last so there is no point in expecting to turn back the clock

It is the time for great merriment but Christmas office parties across London still leave many wishfully thinking back to the good old days.  Despite much talk of an economic recovery, it can still be tough to find reasons to be cheerful about and less cash being spent by companies on seasonal festivities is another reminder of this.  But we should not be asking Santa for a return to the days of lavish Christmas dos with workmates and big entertainment budgets (if they ever did exist).  The economy of old which allowed such excesses could only bring in a few good years of partying before the good times inevitably turned bad. 

Living the high life on borrowed time

The boom times that were still in swing a decade ago seem a long way off.  It was a time when all seemed good with the economy and nothing much would go wrong.  This spirit seemed best exemplified by the exuberance among economists who (mistakenly) thought that their ideas had conquered the ups and downs of the economy.  The great evil of past decades, inflation, had been kept in check and the recession following the dotcom bust passed without much strife. 

This new stable economic environment seemed to benefit the finance sector most of all.  Banks came up with new ways of making lots of money with bankers themselves reaping much of the rewards.  Even some among the rest of us got to enjoy a sprinkling of the good life with many companies splashing out the odd treat on their workers (especially around Christmas time) even if this generosity was not reflected in wages.

The enthusiasm was infectious and we all wanted our share.  The result was loads of new debt as our spending reflected these new aspirations even if our income was lagging behind.  Even the governments in many countries spent beyond their means and got their finances in a mess.  Since inflation remained subdued despite the elevated spending, interest rates never rose by much enabling the debt levels to soar beyond what was prudent.  And banks were only too happy to lend since new financial products, such as mortgage-backed securities, allowed them to pass on increasingly dubious loans to others.

Not banking on trouble

This was one party that could not go on for ever.  An increase in debt is good for spurring the economy along but this can only go so far until lending becomes more reckless.  The final straw was mortgage lending in the United States where new rules encouraged housing loans to individuals who were never likely to be able to afford repayments (so-called sub-prime mortgages).  The many who lost their jobs (including Your Neighbourhood Economist) and even their homes in the ensuing financial turmoil ended up with little to show from the good years.  Yet, on the other hand, the exorbitant pay packets received by many bank employees left them sitting pretty whatever was to happen.

We should all feel repentant like Christmas drinks where we get carried away and make a fool of ourselves.  One way of stopping ourselves getting into trouble is to rein in the banking sector.  This does not mean the equivalent of alcohol-free Christmas festivities but just stricter rules to make sure that things don’t get out of hand.   The perils of too much debt should have always been obvious but it is inability of the banking sector and the financial markets to suitably regulate lending that is perhaps the biggest lesson that we need to address.

Time to sober up

Any economic growth does not count for much if we have to give back most of the gains after a few good years.  Yet, giving up on this easy way of making ourselves richer also means that we cannot expect the economy to grow like in the past.  It will take hard work and sensible policies rather than financial wizardry to make genuine improvements in our standard of living.  The trade-off being that we can create a world where our jobs and what we make for ourselves is more secure.

The government could have a big role to play in this especially since companies are not investing as much as they used to.  Greater spending on infrastructure and education as well as lower medical costs would be a good start to help increase productivity (and wages) as well as going some way to propping up spending.  The solution sounds simple enough but politics is never easy especially at a time when the easy option is for politicians to offer up false promises.  It is voters most of all that need to be realistic in terms of what is achievable.  No party is worth a hangover on the scale of the global financial crisis.

Deflation – déjà vu with a twist

Signs of deflation I have seen before start showing up in my neighbourhood but falling prices have been with us for a long time

Your Neighbourhood Economist has been getting a sense of déjà vu recently – to do with deflation.  My past experiences of falling prices come from years spent living in Japan and I am seeing the same things again in my neighbourhood in London.  Japan and deflation make for a scary combination considering that Japan is a byword for prolonged economic stagnation and poor policy choices.  But deflation may have already been lurking around unnoticed for a while. 

This looks familiar

The symptoms of déjà vu started with the fast food chains such as McDonald’s and KFC offering cheaper menu options.  This first started in London a few years back but it was a sign that consumers did not have much cash to spend.  It is a sorry state of affairs when even the least expensive places to eat out need to provide food with even lower prices to attract customers.  But it is the same tact that similar companies had adopted in Japan around a decade ago in the face of increasing price conscious consumers.

The other memory of deflation in Japan was from buying groceries at the supermarket.  The most notable place was shopping at my local 100 yen store (which is like a pound shop or a dollar shop).  While the prices of the products on the shelves did not change (obviously), there was a noticeable increase in the range of goods that could be brought for 100 yen.  The same trend is becoming more obvious in the UK in the success of discount supermarkets such as Lidl and Aldi.  To keep up, the mainstream supermarkets have been slashing prices but shoppers are still switching to their cheaper rivals. 

The only areas in the economy where prices are still rising are sectors where the pressures of price competition are less fierce.  UK companies such as energy providers or train operators function in imperfect markets where consumers have less choice and few other options.  Spending on energy or transport often cannot be avoided so companies do not have to try hard to sell their products.  As such, it is large energy bills and higher transport costs that are increasingly responsible for inflation.  With nowhere else to go, consumers have increasingly turned to the government to prove an answer despite there being little that politicians can do.

We live in deflationary times

Yet, for good or bad, this may be the new world that we live in now rather than just a temporary blip amid a slow economic recovery.  In a new global era, firms and consumers can scourge the world for the cheapest places to buy whatever they want.  This impacts what we buy off the shelves at our local store as well as what we can purchase off the internet.  Technology further aids this trend by providing information on what is on offer outside of our neighbourhoods and for what price.  And we are increasingly consuming services through the internet at cheaper rates than ever before.

This is great for us as consumers but the flipside is that companies in our local economies face growing pressures and will not be able to provide the same level of employment opportunities or pay the same wages as before.  This is a problem for governments who want their national economies to prosper.  Jobs are seen as the primary gauge of the health of the economy but boosting employment is tricky when competing on a global scale.

Here today and here tomorrow

Deflation is often seen as a problem in itself.  The standard economic theory goes that, if prices are falling, consumers will wait to spend as goods will be cheaper tomorrow.  Yet, globalization and technology are not something new and we have had downward pressure on prices for a long time.  Inflation has been low for the past few decades suggesting that deflation may have not been that far away.  It is perhaps only the voracious appetite for raw materials in China and elsewhere that pushed up global commodity prices and stopped deflation setting in sooner.    

If it has been around for so long, deflation by itself may not be so bad after all.  Yet, an overreaction by policy makers might be.  The European Central Bank seems set to ramp up its measures to fight off threats of deflation (and a morbid economy in Europe).  The central bank in Japan has launched a renewed onslaught against falling prices but to little avail.  Yet, the forces of globalization and technology cannot be reversed using just monetary policy.  Falling prices are something that may be with us for a while so it is better to get used to living with the potential for deflation and focus our efforts on other economic evils.

Economic Recovery - Downgraded

Amid talk of economic recovery, we may not get back to living the life we had in the past

Being downgrading can be tough – no one likes having to get by with less – but this is what we might have to put up with regard to the economy.  Life was much easier around a decade ago when we were enjoying the perks of strong and steady economic growth.  But the upgrade was likely temporary when considering that it was funded with a borrowing binge that was unsustainable.  With wages likely to continue to stagnate for years to come, we may not have it so good again for a long time.

Anything but first class

Gains in wages are typically the main route to the good life for most of us.  Bigger pay packets at the each of the month give us more money to spend.  This money goes back into the economy to create a virtuous cycle helping create a healthy economy so that wages to rise again in the future.  The main avenue through which wages rise is higher output per worker.  This involves people being put to more productive use whether through raising their levels of skills, working together with machines or computers, or doing business in a better way.  The economy usually operates to ensure that this happens automatically as businesses, which want to maximized their profits, will try and make the most of their staff. 

Yet, the past few years, if not the past few decades, have shown us that the tendency for higher wages is not something that we can take for granted.  This is because the two forces of globalization and technology have made life tougher for many people in richer countries.  The sectors of the economy which typically supported the middle class with stable and steady jobs have been eroded.  Jobs such as those in manufacturing along with clerical work have been either moved to countries where labour is cheap or increasingly carried out by machines or computers. 

This has led to a polarization of the work force between high and low skilled areas with a shrinking middle ground.  At one end of the spectrum are bankers, IT experts, and professionals whose knowledge and training ensure a high level of pay.  The rest of the workforce is left with menial jobs such as taxi drivers, shop assistants, and delivery personal only because these are jobs that can’t be shipped overseas.  On top of this, austerity measures in many countries also mean that public sector workers are also suffering.

No route out

With many of us now competing with machines or overseas workers, our bargaining has been considerably diminished.  So while wages rises is a perk that many are missing out on, profits for many businesses have never been higher.  Profitable firms could be the agents of economic growth by expanding their operations and investing in more equipment.  Yet, with weak wages crimping consumer spending, most companies prefer to hoard their cash until the economic recovery is more robust.   What seems like a common sense strategy for each firm has added up to a prolonged slump for the economy as a whole.

The government could step into the breach and provide the investment in worker training or infrastructure to boost productivity.  Yet, the infiltration of pro-market economic theory has pushed the government to the sidelines of the economy.  Even the wealth that had been created in the boom years before the crisis was only benefiting a small portion of the economy.  One example is the finance sector that was creating wealth that mostly went to those working in finance rather to the economy as a whole.  Building a road or new schools creates benefits now and in the future while repackaging of loans only generates money for a lucky few working in banking.

Stuck with a second class economy

Workers have been battling with the consequences of globalization and technology for decades but could rely on debt in the past to enjoy some of the high life.  But like an ever expanding credit card balance, this spending spree was never built to last.  To make things worse, even politicians got involved.  The US government with Bush junior in charge slashed tax rates while the Labour government spent lavishly on the UK public sector around the turn of the century. 

Government finances had been boosted by economic growth fuelled by debt but this was a luxury that would prove fleeting.  Now government is like the rest of us in having to cut back.  Without many goodies going around, voters are likely to become increasing tetchy.  Politics is also getting ugly with constructive policy making likely to go out the window.  Low interest rates and more debt have been offered up as a way out but this creates even more problems in the absence of economic growth.

Something special will be needed to get both consumers and businesses to hope for something better.  Yet, the grim realities of life mean that this may not happen anything soon.  Like being in a long haul flight in economy class, we might be stuck here for a while.  

Economic Recovery – Reasons to be Pessimistic

The economy seems to be picking up so why are economists still so dour?

Economists are not known for being moody but many are depressed when it comes to the state of the global economy.  This seems out of place at a time when economic recoveries in some countries are showing signs of taking hold and stock markets are setting record highs.  The mood among economists was already negative after being caught out by the global financial crisis.  Are economists right to be worried or just hung up on past mistakes?

Why so glum?

My father inquired, after a recent post on my blog, why my views had to be so downbeat.  Given that much of the business cycle is driven by the sentiment of consumers and businesses, his line of thinking was that the economy would jump back to life if we could all just be more positive about the future.  People would spend more while companies would invest and take on more workers.  All we would need is economists to tell us that everything will be alright.

The problem is not that economists are always a grumpy bunch.  The problem is the opposite – that economists have been overenthusiastic in the past.  This optimism was fuelled by a belief that economic theory could provide a route to a steady rise in prosperity.  Instead, economists have been chastened as a result of their previous ideas being proved wrong by the global financial crisis.  The crisis has also focused minds on what can go wrong.  Now, even periods of prosperity are seen to have a darker side and to create the seeds for trouble in the future.

Grumpy for a reason

It may just be the case that economists are caught in a crisis of confidence.  There is a core belief among economists that markets have the ability to correct themselves.  This means that any periods of weak economic growth should only last until the economy gets back on its feet again.  There is much data on the economy to get excited about.  Consumer spending is up, buoyed by the job market recovering faster than expected.  The worst of the crisis seems to be behind us and stock markets reflect this new upbeat outlook.

Yet, economists have learnt their lessons and know better than to place too much trust in the data.  Behind the numbers lurks a less cheerful story.  Investment by companies is low with few businesses seeing opportunities to expand despite balance sheets laden with cash.  One reason for this is that labour productivity is weak.  This means that the extra earnings for companies from employing more workers are likely to be poor.  Low labour productivity also implies that wages are not likely to rise much which raises concerns about whether households will struggle to pay off rising levels of debt.  A lack of new innovations suggests that investment and productivity may not improve for a long time to come, prompting talk of prolonged stagnation.

When the markets are not functioning normally, it is typically the government that steps in to correct any problems.  However, the governments in many countries have been more hindrance than help.  Mismanagement of government finances, slow and timid responses to crises, and a lack of forward-looking policies are common complaints.  With voters lacking genuine alternative political parties, politicians have become engrossed in petty political positioning rather than constructive policy making.  Managing the economy has been left to central banks which has caused its own problems. 

This is why Your Neighbourhood Economist is one of many who struggle to find reasons for cheer.  It would be great to be caught up in the euphoria that has taken hold of the financial markets but economists have been burnt too badly to get carried away.  Only time will tell if the gloom among economists is warranted.

Measuring the Economy – A Knotty Problem

A change in focus is needed to make a real difference when measuring economic growth

Measuring the economy can be a bit like estimating the length of the proverbial piece of string.  Even pinning down what to measure before taking out your tape measure is tricky.  What is measured takes on even more importance when it is tied into government policy which aims to make us all better off.  This is a sobering thought at a time when improvements according to the traditional yardstick of GDP often fail to make a difference to the lives of many of us.  Changing what is used as a gauge for economic improvement can have significant consequences for the outcome of economic policy.

Being strung along by GDP

Rising inequality is a hot topic among economists at the moment.  Data shows that the wealth of the rich has increased considerably faster than for the less well-off over the past few decades.  Much of this can be attributed to the forces of globalization - a shortage of

skilled workers in the global marketplace has pushed up their pay while the opening up of countries such as China has resulted in a glut of low-skilled workers which has depressed their wages.  Technology has also added to this trend with computers reducing the clerical and administration work that had been a source of jobs for middle class workers.

Some see inequality as a necessary part of a capitalist economy with industrious people earning more due to their own hard work.  Others point to the social costs of inequality such as higher crime and more health problems and call for more policies to stem this trend.  The lack of advances in the earning power of a large portion of the population will inevitably have serious political consequences such as the rise of populist movements or a growing mistrust of capitalism among young people.  The issue is all the more urgent as it comes at a time when Western countries are struggling to maintain their place at the top of the global pecking order.

The combination of austerity measures and loose monetary policy in most countries is not doing much to address this issue and may be making the situation worse.  Cuts to government spending disproportionately hurt the less well-off while the wealthy have benefitted as quantitative easing has driven up stock prices.  These policies are based on the premise that creating growth in the overall economy will benefit us all.  But the data shows that, for example, while GDP in the UK is expected to reach its previous 2008 high this year, it will take a few more years for average earnings to recover lost ground. 

A different piece of string

The overall size of the economy is becoming increasingly difficult to measure.  So it might be better to focus more on the bit that matters most to people – what they earn and can spend.  Using median (real) earnings as a gauge of the economy would mean that economic growth would be more tangible for more people.  It is also a more simplistic measure which would require less manipulation although it would require some adjustments (to take into account changes in what we spend our money on and whether those goods change in price).

It would be a simple alteration that would have major implications for economic policy.  The welfare of normal people would be the central focus with other related issues such as unemployment also taking on greater importance.  Yet, this would not be a license for wages to rise inexorably as businesses would suffer and any artificially manufactured gains would only be temporary.  On the other hand, measures to help companies, such as lower corporate taxes, would also need to have a positive effect on wages. 

Increasing the median wage would have a more profound effect on the health of the economy and would involve more than simply boosting spending through an increase in debt.  Making progress on this goal would require more long-term policies such as investment in education and reskilling workers in declining sectors.  Lifting earnings would be hard work but the positive results would be genuinely worth the effort.