A Blog by Jonathan Low


Sep 13, 2013

Productivity Isn't Everything: The Curiously Deficient Relationship Between Investment and Growth

There was a famous lite beer commercial whose running gag line pitted those who thought its most salient attribute was that it was less filling while their opponents shouted that it was more taste.

In the fifth year of the recession - and counting - we find ourselves facing a similar dispute. The majority of those on the side of austerity and private investment claim that without relentlessly lower taxes and  a reduction in the attendant government services, investment will wither and growth will be stifled.

Those who believe otherwise think that the problem is really one of redistribution and stimulus: without government intervention and some redistribution to lower income families in order to rekindle the consumer markets, growth will continue to lag.

Although such debates are rarely about facts and all too often based on ideology and personal financial interest, the more persuasive argument does appear to be emerging. And counter to all of their efforts to deny the data, the stimulative redistributionists appear to be winning. Austerity has failed to achieve most if not all of its stated goals - rather spectacularly, some would claim. The re-stated numbers get even worse.

Furthermore, the markets' negative reaction to the US Federal Reserve's 'tapering' pronouncements - signalling that the Fed is determined to try to wean the markets off of the government support that has quietly bolstered them for lo these many years - has sent said markets into a tizzy. Life without government stimulus for the markets? Unthinkable! But support for the consumers who actually drive the economy, say these titans of economic logic: more government waste!

It is increasingly clear that the austerity programs and other oligarchically popular support mechanisms have run their course. How long the various polities suffering from these regimes will continue to tolerate them is the drama being played out before our eyes now. JL

Samuel Brittan comments in the Financial Times:

There is nothing wrong with the US economy a measure of redistribution would not put right.
Economists are often accused of an obsessive preoccupation with real gross national or gross domestic product, two closely related measures of national output. These measures have their uses. They show that, among advanced industrial countries, the US has made the most impressive (but still modest) recovery from the pre-crisis peak of 2007-08. The UK remains below that peak, sharing the dunce’s cap with the euro area. Nevertheless, promoting GDP at all costs would be an insane objective for long-term economic policy. GDP would be maximised by opening a country’s frontiers and promoting mass immigration. Maybe some of the immigrants would be unemployed or, in other ways, be a charge on social security. But, so long as there is a net addition to the labour force, the country’s GDP would almost certainly rise, however overcrowded and unbearable the country might be to inhabit.
A less bad approximation might be GDP per worker. But even that borders on the absurd – for it might be maximised by compulsory increases in working hours at the expense of leisure. A better measure might be GDP per hour worked, often known as productivity. This at least does not foreclose the choice between work and leisure, which as far as modern production methods allow should be left to individual choice. I have been aided in examining the record here by a thoroughgoing piece of research by independent economist Andrew Smithers.
In the past 20 years, output per hour has grown by an average of 1.5-2 per cent per year in the leading industrial countries. But in the three years to the beginning of 2013 there has been a major reversal. US productivity has on this measure slowed to a crawl of 0.3 per cent growth per year, and the UK has achieved a magnificent average of minus 1.2 per cent. Germany and Japan are not doing all that well, but are at least in positive territory.
Do these dismal figures just reflect the slow recovery from recession of the two English-speaking countries, which will be reversed if recovery continues and gathers pace; or has there been a fundamental change for the worse? Mr Smithers fears the latter. Like most modern economists, he concentrates on quantifiable relationships. The most easily quantifiable aspect is the relation between investment and productivity growth. But despite the sermons on his subject from leftwing political economists, from UK Prime Minister Harold Wilson onwards, there is little long-term relationship between investment and growth.
It is worth concentrating instead, if the reader will excuse one piece of jargon, on the incremental capital to output ratio, or ICOR. This measures how much investment is required to produce a unit increase in output. Thus the lower the ICOR, the greater the apparent efficiency of the economy. ICORs are best estimated over long periods to reduce business cycle influences. On this measure, the US and the UK seem, surprisingly, far more efficient than Japan and Germany over a 20-year period, whether one looks at total or just business investment. But in the three years to the beginning of 2013, there has been a dramatic reversal by this measure, too. US ICORs have been lower than those of Japan and Germany, whereas British ICORs have shot up right out of the page.
Looking at intermediate periods, Mr Smithers fears that the rise in the US ICOR is more than a passing phase and that the productivity of new US capital has halved. Taking into account both productivity trends and the likely growth of the US labour force, he believes that the current US recovery will soon run into an inflation barrier and that the optimism of mainstream opinion at the US Federal Reserve is misplaced.
Where I differ from Mr Smithers is in the policy conclusions. The US is by far the richest country in world history. The Financial Times books section is nevertheless groaning with treatises on how US business needs to pull its socks up. (One of the better examples of this genre is the new McKinsey report, Game Changers). But suppose good advice is not followed? There is nothing wrong with the US economy that a measure of redistribution towards both the less well-paid and public services would not put right. Some suggest this reallocation has gone further than generally realised but still has a good way to go.
Output per hour in the British economy is, however, still far below that of the US, and the ordinary British citizen would benefit from an approximation of performance towards American levels. This may require fundamental changes along the lines put forward by management experts and efficiency gurus. But I would try a bit of Keynesianism as well. How far the form of forward guidance set out by Mark Carney, governor of the Bank of England, may indirectly help in this direction by underpinning the current recovery is a matter I hope to discuss next month.


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