Saturday, August 29, 2009

Productivity and Jobs

America’s annual gain in productivity in many sectors of the economy is often overlooked as a source of saving. Productivity is measured by output per work hour and the gain in productivity is measured by the percentage increase in output per work hour.

If productivity in appliance manufacturing goes up 3 percent, then a 3 percent increase in appliance manufacturing takes place at the same cost, or the same output can be produced with a 3 percent cost savings, or a combination. The manufacturing firm is the first beneficiary of the savings from a productivity increase because it lowers costs and the savings translates into profits.

Selling extra output puts downward pressure on prices because it is almost always necessary to lower price to sell more output, including appliances. In this way a productivity increase can generate savings for consumers from lower prices.

Productivity also affects employment. If a price decrease leads to a 3 percent increase in appliance sales following a 3 percent increase in productivity, then employment will remain the same.

However, there could be more than, or less than, a 3 percent increase in appliance sales. If it’s more than 3 percent, then more jobs will be needed and employment will go up, but if it’s less, then layoffs result. The newly unemployed will have to look for work at other firms or other industries.

Whenever productivity goes up there are savings with potential benefits for business owners as higher profits, consumers as lower prices, and job holders as more jobs and higher wages. In the 1980’s advances in computer technologies raised productivity so much that business earned new profits, consumers saved with falling prices, and new jobs opened up as business competition for workers with computer skills raised wages and employment.

National productivity continues to go up across many industries, but lately at modest rates. How the savings from productivity are distributed varies, but working Americans are in the worst position to benefit. For nearly 20 years manufacturing productivity and sales have been going up but jobs in manufacturing have been going down. As people leave manufacturing for other jobs they flood service sector job markets.

With a growing percentage of Americans looking for work in service industries, it gets harder and harder for labor to share in productivity gains with better wages. For industries like health care and education where productivity gains generally lag behind, continued growth of these services helps to increase jobs. The skills needed for these jobs limit applicants and make it necessary to pay better wages.

For other service industry though wages are not going up and productivity gains go to business. Productivity gains amount to national savings, which can benefit everyone. Lately though they are contributing to America’s inequality of income.

Thursday, August 6, 2009

Depression Economics

The Return of Depression Economics and the Crisis of 2008, Paul Krugman, (New York: W.W. Norton & Co., 2009), 191 pages, no index or bibliography, $24.95.

The first sentence in The Return of Depression Economics reads “Most economists, to the extent that they think about the subject at all, regard the Great Depression of the 1930’s as a gratuitous, unnecessary tragedy.” That is economists agree on the causes of depressions and the policies that end them.

Since the economics profession agrees the Great Depression was caused by inadequate aggregate demand, or inadequate total spending, made worse by a folly of bad policy, depressions are a problem solved, and a thing of the past.

But not so fast, says Krugman, who argues through the remainder of the book that recent global crises have similarities to each other and the Great Depression, especially similarities in banking and credit.

Banks are essential, but troublesome institutions that keep checking accounts for depositors, but only hold a fraction of deposit liabilities in reserve to pay for checks. In practice they hold around 15 cents on the dollar in reserve and make loans with the other 85 cents.

In the normal course of business 15 cents will be adequate because those writing checks will about equal those making deposits. In the normal course of business borrowers will be paying monthly principal and interest to further assure that banks have reserves to pay on their checking accounts.

Banks direct savings back into the spending stream as investment spending. Loans can generate more income and employment and help the economy grow, but banks can disrupt the flow of spending when they make risky and foolish loans. Loans that default disrupt the flow of spending and can create recessions and depressions.

There in lies the trouble, or moral hazard, a term used by Krugman to characterize “any situation in which one person makes the decision about how much risk to take, while someone else bears the cost if things go badly.”

Krugman gets right to the heart of the matter on page 63 when he writes “Borrowed money is inherently likely to produce moral hazard. Then he makes up a story of a modern moral hazard.

“Suppose that I’m a smart guy, but without any capital, and that based on my evident cleverness you decide to lend me a billion dollars to invest any way I see fit, as long as I promise to repay within a year’s time. … If the investment prospers, so will I; if it does not, I will declare personal bankruptcy, and walk away. Heads I win, tails you lose.”

Walking away from billions in loans brings a halt to billions in transactions that amount to hoarding cash and pulling money out of the spending stream. It can also lead to panic selling of financial assets.

Krugman’s story and narrative accounts of global recessions reflect his tendency to believe that people can be greedy, irrational and destructive in their economic behavior. Unlike so many in the economics profession he does not see panics, crises and recessions as just another technical matter. Narrative from the recent panics and crisis of Mexico, Japan and Asia that dominate the first four chapters reflects his views on human perversity.

Chapter 5 is the first of four more topical chapters that cover the problems of currency speculation and then “hedge funds” and their relation to crisis, panics and recessions. Krugman takes a few jabs at former Federal Reserve Chairman Alan Greenspan in Chapter 7 titled “Greenspan’s Bubbles.” The bubbles are the stock market bubble and housing market bubble.

Chapter 8 takes a quick tour through banking in order to define shadow banking. Because a bank’s liabilities include personal and business checking accounts, i.e. money, the larger society has a special need to regulate banks to make sure they have reserves to meet their account liabilities. Shadow bankers figured out new and innovative ways to make loans with other people’s money like banks do, but avoid regulations requiring a minimum of reserves to meet account liabilities.

Shadow bankers did the same thing as Krugman’s smart guy above so we are not surprised when he writes this simple rule: “… anything that does what a bank does, anything that has to be rescued in crises the way banks are, should be regulated like a bank.”

The first eight chapters are really a preliminary for Chapter 9 because elements of the crisis in Latin American, Japan and Asia all re-occur in the American crisis of 2008 and 2009. Krugman brings them all together in a chronology starting with America’s housing bubble, then America’s hedge fund failures and the worst of all, the collapse in monetary policy as an economic stimulant to total spending.

The last chapter makes sobering reading as its title, The Return of Depression Economics, so well implies. Krugman defines depression economics as recession brought about by inadequate aggregate demand: decline amongst plenty.

He suggests two immediate policies to get through the 2008 and 2009 recession: get credit flowing again and prop up spending. The phrase “get credit flowing again” jumps out like a jewel on the head of a toad, at least to those in economics, banking and policy. That is because monetary policy and lower interest rates should always get credit flowing again.

Instead of traditional policies Krugman breaks with the past and suggests direct action to recapitalize banks and have the Federal Reserve Bank enter commercial paper and other lending markets. Likewise he doubts monetary policies will be effective and recommends government spending as a stimulus for right now, or as long as necessary. He doubts tax cuts will be effective either; after all taxpayers can save, not spend.

Krugman is one of a small group who are well known within the academic ranks but decide to write to a larger general audience. Lester Thurow would be another but the list is short. It is hard to do because academic journals will not publish journalism, but the popular press must have something readable and saleable.

Depression Economics is relevant and current events journalism with some elements of a textbook. It has some enduring economic analysis and historical material but remains readable and avoids the strident tone of a crusader. He does criticize his opposition and Alan Greenspan. There is nothing about income inequality or its contribution to inadequate demand.

Unlike so many in economics who will not acknowledge that free enterprise breaks down or fails, Krugman sees a break from the past and argues for what works and whatever is necessary. Depression Economics reflects that approach.