Category Archives: Growth Causes and Consequences

Robert Litan on the Aging of U.S. Firms

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He writes,

In a study just published on the Brookings Institution’s Web site, Ian Hathaway and I found that the share of mature firms, or those at least 16 years old, rose 50 percentage points between 1992 and 2011, from 23% to 34% of all firms in the U.S. economy. Not surprisingly, the share of all private-sector workers employed in such mature firms rose over the same time, from 60% to 72%.

This is, of course, the opposite of what I would expect, given the stimulus to entrepreneurship provided by the Internet. I would like to see more discussion of this finding on other economics blogs.

Taking Gains as Leisure

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The BLS’ Shawn Sprague writes,

workers in the U.S. business sector worked virtually the same number of hours in 2013 as they had in 1998—approximately 194 billion labor hours.1 What this means is that there was ultimately no growth at all in the number of hours worked over this 15-year period, despite the fact that the U.S population gained over 40 million people during that time, and despite the fact that there were thousands of new businesses established during that time.

And given this lack of growth in labor hours, it is perhaps even more striking that American businesses still managed to produce 42 percent—or $3.5 trillion—more output in 2013 than they had in 1998, even after adjusting for inflation.

Pointer from Timothy Taylor.

Some comments:

1. The gains in real well-being can be vastly under-estimated or over-estimated, depending on how well one adjusts for inflation and other factors, like un-measured consumers’ surplus and the greater variety of goods and services to choose from. My own view is that the gains are somewhat under-estimated.

2. There has been a large increase in leisure. How much of this is a welfare gain, though? My hypothesis is that many more people would work if government policy did not create so many disincentives to supply and demand labor. Just look at Social Security, with its huge payroll-tax disincentive for young people to work and its large subsidy to older people to consume leisure. If my hypothesis is right, then reducing these disincentives would lead to a lot more market work and a slower growth rate in leisure.

3. What accounts for the increase in leisure since 1998? The biggest factor is probably demographics, as many Baby Boomers have gone from prime working years to retirement years. Next, I point to factor-price equalization and to an increase in the wedge between compensation and take-home pay represented by health insurance costs. For the most recent five years, give some weight to Casey Mulligan’s narrative. A lot of economists would point to aggregate demand, but I no longer respect that concept.

A Smithian Theory of Inequality

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It seems that Piketty offers one stylized fact about inequality, which is that it rose during the long 19th century, fell during the period of the World Wars and their aftermath, and has risen since. What might explain this?

I would offer a theory in the spirit of Adam Smith: the division of labor is limited by the extent of the market.

My theory is that the more division of labor, the greater the inequality within a nation. Of course, from a world perspective, inequality may go up or down, and in recent decades it has gone way down.

The long 19th century was an era of globalization. World War I interrupted that, and there was little recovery of international trade between the wars. After World War II, trade also was limited. We had the cold war, which isolated the East from the West. We had economic policies in many countries that were anti-trade (remember import substitution?). Finally, in the 1980s, we began to see liberalization in the West, and then greater liberalization in China, India, and some of the former Soviet bloc. Then we had the Internet, which opened up new opportunities for specialization and trade.

This unleashed a new round of globalization, and the “extent of the market” became greater. The business opportunities this created helped to increase inequality within nations. At the same time, incomes increased in India, China, and several other poor countries, so that world inequality fell.

This theory won’t give me a best-selling book. But I think it has merit.

No One Standard of Living

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John Cochrane writes,

The deeper point is that things are getting cheaper and cheaper, and people — services provided with their expertise — are getting more and more expensive.

He points to an NYT chart showing plummeting prices for goods and soaring prices for education, health care, and child care.

My view is that a lot of spending on these services is discretionary (not all of it, of course). I think this makes any broad statement about “the” real wage incorrect. See my essay on that topic.

What I’m Reading

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It’s the book that you’re not supposed to read. A Troublesome Inheritance: Genes, Race and Human History, by Nicholas Wade. Robert VerBruggen reviews it.

An overarching theme is that while institutions matter greatly — just look at the difference between North and South Korea — it is possible that some institutions are better able to take root if certain genetic adaptations have already taken place. If human populations in some parts of the world, but not others, evolved slightly higher levels of trust, a slightly greater tendency toward nonviolence, and so on — perhaps because population density forced them to live in close proximity to each other, abandon tribalism, and develop states — that might help to explain why some populations have become unusually peaceful, democratic, and economically productive.

It seems that many people disagree with parts of the book, although they disagree with different parts. If I were Brad DeLong, I might say that this proves that the book is basically right. But I’m not and I won’t.

What’s Wrong With the Neoclassical Production Function

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The NPF makes sense in a simple context. Suppose you are an entrepreneur with a fruit orchard. You can pay to have fruit trees planted. That is your capital. After a while the fruit trees mature, and you hire workers to pick and sell the fruit. That is your labor. The function Y = f(K,L), which says that output is a function of capital and labor, is a reasonable model that can help to predict your decisions and the share of income that goes to your workers.

Economists from Ricardo to Piketty have wanted to describe the relationship between economic growth and income distribution in terms of simple laws. For the past fifty years or so, the NPF has been the go-to tool for economists trying to do this. Mathematically, it is very elegant for that purpose.

But thinking of the economy in terms of an aggregate NPF has many problems, including the following:

1. Capital aggregation. There is a huge, huge literature on this (see “Cambridge capital controversies”). The result was that the economists who claimed that you cannot construct a meaningful aggregate out of different types of capital equipment won the theoretical battle but lost the practical war. That is, those who use capital aggregation admit that it is bogus, but they go ahead and do it anyway. It’s a matter of “I need the eggs.”

2. Solow residual. The NPF can account for only a small fraction of changes in economic growth over time or differences in productivity across countries. The unexplained differences are known as the Solow residual. Again, there is a huge literature devoted to this issue.

3. Labor heterogeneity. In the NPF, there is one wage rate, which is what is needed to induce you to give up an hour of leisure. In the real world, there are many different salaries paid to different people.

4. Capital proliferation. Over the past fifty years, economists have conceptualized many types of capital. We now have human capital, social capital, organizational capital, institutional capital, environmental capital, network capital, consumer capital, cultural capital, knowledge capital, innovation capital, and so on. Some forms of capital help with understanding labor heterogeneity. Other types help with the Solow residual. But these multiple forms of capital mess with the simple NPF and with the correspondence between theoretical concepts and real world data.

5. Knightian uncertainty. Unlike our theoretical orchard-owner, real-world entrepreneurs must cope with the fact that the return on a particular investment is unknown ex ante. The distribution of income among capitalists is affected by differences in ex post returns. Moreover, since so much of “labor” income is an accrual to human capital, all of us are capitalists, and hence most “labor” income is subject to differences in ex post returns.

So, should we use the NPF to guide economic policy to try to achieve the best balance among growth and the distribution of income? Some possibilities:

(1) The criticisms of the aggregate NPF are not important, so that policy conclusions are still sound.

(2) Some of the criticisms are devastating, but we need some tool to guide policy, and until something better comes along our best choice is the aggregate NPF.

(3) Some criticisms are devastating, and as a result we should be very cautious and humble about making policy pronouncements based on our understanding of the NPF.

To me, (3) makes the most sense. But that is not a popular position at the moment.

Greg on Greg

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Meaning Cochran on Clark.

If moxie is genetic, most economists must be wrong about human capital formation. Having fewer kids and spending more money on their education has only a modest effect: this must be the case, given slow long-run social mobility. It seems that social status is transmitted within families largely independently of the resources available to parents.

Pointer from Jason Collins.

Nick Rowe on Secular Stagnation

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He writes,

What is it with you townies? Have you never looked out of the window, when you fly (do you ever drive?) from one city to another, and wondered about all that stuff you see out there? It’s called “land”. It grows food, that you eat. And that land is valuable stuff, and there’s a lot of it, and it can last a very long time, and it pays rent (or owner-equivalent rent). And if the rent on that land is strictly positive (which it is), and if the price of that land is finite (which it is), then the rate of interest you get by dividing that annual rent on land by the price of land is going to be strictly positive. And that’s a real rate of interest, because land is real stuff, and what it produces is real stuff too.

So when you go to a helluva lot of trouble to build a model with a negative equilibrium real rate of interest, and it’s a very fancy complicated model, but it totally ignores land, I really wonder where you are coming from. Actually I don’t wonder. I know where you are coming from. You are coming from the town, or the big city, where you can easily forget about land. But even then: you know that stuff your house or condo is built on? That’s called “land” too.

My Review of Brynjolfsson and McAfee

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Is here. An excerpt:

Back at the turn of the millennium, these applications seemed to Kurzweil to be on the near-term horizon. These strike me as the same applications that Brynjolfsson and McAfee suggest are on the near-term horizon today. While a few of Kurzweil’s other predictions did materialize, and while some of these applications are certainly closer to reality today than they were in 1999 or 2009, we should be wary that some of what The Second Machine Age tells us to expect may not in fact appear for several decades, if ever.

The Labor Market: Four Takes

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1. Josh Barro writes,

For four decades, even in stronger economic times, wage gains have not kept pace with economic growth. Wages and salaries peaked at more than 51 percent of the economy in the late 1960s; they fell to 45 percent by the start of the last recession in 2007 and have since fallen to 42 percent.

I would note that a very important part of that trend is the shift from “straight” wages and salaries to other forms of compensation, notably health insurance. Higher payroll taxes also play a role. The share of total compensation to GDP held up fairly well until recently. One might argue that with offshoring, capital-labor substitution, and the relentless climb of non-wage benefits costs, the elasticity of demand for labor is starting to yield declines in labor income.

2. Catherine Rampell writes,

The share of people getting laid off each month — as well as, more disturbingly, the shares getting hired and quitting their jobs — is near record lows. That’s according to Labor Department data released this week and calculations from John Haltiwanger , an economist at the University of Maryland. Haltiwanger estimates that private-sector layoffs, hires and resignations are 21 percent to 26 percent below their rates two decades ago.

This is important information, and Rampell wisely points out that there are a number of plausible explanations, with rather divergent policy import.

Incidentally, I agree with Tyler Cowen that it is good to have Barro and Rampell joining the ranks of columnists. I look forward to op-eds that I might actually have to read in order to find out what they have to say.

3. Bill Gates says,

I think tax structures will have to move away from taxing payroll. … Technology in general will make capital more attractive than labor over time. Software substitution — whether it’s for drivers or waiters, nurses … it’s progressing. And that’s going to force us to rethink how these tax structures work in order to maximize employment given that capitalism in general over time will create more inequality, and technology over time will reduce demand for jobs, particularly at the lower end of the skill set. We have to adjust, and these things are coming fast. Twenty years from now, labor demand for lots of skill sets will be substantially lower, and I don’t think people have that in their mental model.

James Pethokoukis points out, as I would, that Gates’ views align with a growing literature on this topic.

4. Mark Perry writes,

one of the reasons for the disappointing monthly employment reports is the persistent weakness in the public sector employment, which is offsetting the relatively healthy increases in private sector hiring that is 63% greater than private job creation during the last recovery.

I am not sure that his numbers line up with his rhetoric. Relative to the labor market as a whole, the weakness in public sector employment strikes me as pretty small. To put it another way, if you were to restore all of the government jobs that have been lost since the start of the recession, the employment-population ratio would be maybe .3 or .4 higher than it is now, but still about 4.0 below what it was before the recession hit.

I suspect that state and local governments have been constrained by low property taxes and increases in Medicaid spending. Also, if they have to hold down employment because of the strain of pensions, that would not surprise me.