Saturday, June 11, 2016

On the productivity puzzle: Does business investment explain it all?

Following up on last week's "Productivity Growth: It's the Investment, Stupid".
James Pethokoukis at AEI's Ideas blog, June 10:

This, I would venture, is a pretty illuminating econ chart. It comes from the White House econ team. Productivity growth has been glacial since the end of the Great Recession. And a collapse in “capital intensity” plays the biggest role. From the CEA’s Jason Furman:
Historically, investment per worker-hour—referred to as capital intensity—has added nearly 1 percentage point to labor productivity growth, nearly matching the contributions of “total factor productivity” to total labor productivity growth. But since 2010, capital intensity has been a drag on productivity. Moreover, reduced capital deepening can account for two-thirds of the below average productivity growth in recent years. This is contrary to the usual historical pattern whereby the contributions of capital intensity to productivity growth are relatively constant across time while the major variations in labor productivity growth have been largely driven by variations in total factor productivity growth.
Or as Andrew Smithers recently summed up in the FT, “Failing to recognise that poor productivity is the result of low investment is very damaging, as it deflects attention from why investment is so low.”
So why, then? Smithers blames a variant of short-termism: “The bonus culture rewards chief executives who keep investment down.”

The primary CEA explanation puts demand front and center: “… businesses invest because they expect consumers to buy their products in the future, not simply because they currently have high profits or substantial retained earnings.”

And a good part of this might be blamed on the aftermath of the Great Recession. The nasty downturn “led to more cautious investment plans, such that it has taken longer than usual for an improved outlook to translate into new investment projects.”

Now if the capital stock were actually shrinking, that would be very serious indeed. But that does not seem to be the case. Goldman Sachs adds to the CEA explanation just a bit:
… the very weak contribution of capital deepening to productivity over the last few years should not be seen as evidence of a pitiful level of investment spending. Rather, the capital stock has actually grown at a respectable pace in recent years, roughly in line with its usual relationship with potential labor force growth. But actual employment has grown much faster than the potential labor force as the economy has moved towards full employment.
In any chase, this is an argument about cyclical weakness. At this point — seven years after the end of the Great Recession — time should be on our side. The CEA: “Regardless, the improvements in business sentiment in recent years should be viewed as a support to investment growth in the United States.”

And Goldman: “We expect the contribution from capital deepening to be roughly zero this year, but to increase in the years ahead as employment growth decelerate…. We think the cyclical effects on capital deepening and labor quality account for about half the gap between the ½% actual productivity growth rate over the past few years and our 1½% estimate of the measured long-term trend. This drag should gradually diminish as job growth converges to its long-term trend over the next 1-2 years.”...MORE
Way back in 2013's "Why Capital Gains Should be Taxed as Income" I threatened:
One of these days I'll get around to doing a "The diminishing returns to capital deepening" post, or somesuch. 
I'm still thinking I'll get around to it. In the meantime here are some prior posts that touch on some of this stuff:
Atlanta Fed: "What Seems to Be Holding Back Labor Productivity Growth, and Why It Matters"
A Roundup on Robots, Capital-biased Technological Change and Inequality (plus how to tell if a person is a fiduciary)