A New Picture of The American Economy

We have long supposed and have been frequently told that America's economic troubles stem from our declining productivity growth. Yet the basis for this belief is now eroding. Early in 1991 we learned that during the 1980s our manufacturing productivity grew at 3.6 per cent per year, an "unbelievable revival" in the words of The New York Times. And this revival is as mysterious, as opaque to economic science, as the decline that it seems to have superseded. If the gloomy consensus is now giving way, it is certainly not to optimism, but to confusion.

Most economists had accepted the fact of productivity decline without ever having settled the question of how and why it happened. Around the presumed fact of decline, and despite the acknowledged dissensus as to its cause, liberal economists in particular built a core of policy doctrine. They now must face the question whether that policy doctrine stands independent of the changing evidence about productivity or falls victim to it.

Moreover, if productivity decline does not explain our economic problems, what better explanation is there? I will argue that we can find much of the explanation in an alternative picture of the American economy that brings into sharp resolution the different paths taken by American industries in response to the challenge of international trade.

Demystifying Productivity
Most economists believe that economic growth and prosperity depend fundamentally on productivity. Productivity, by definition, is the ratio of physical outputs -- the goods and services that make up the gross national product -- to the physical inputs, the land, labor, and capital goods used in production. Usually economists simplify the computation by focusing on "labor productivity" -- the ratio of total outputs to the total hours of work. Productivity growth as conventionally measured is the change in that ratio from year to year.

When labor productivity growth slows down, as it apparently did after 1973, the cause may be a decline in the ability or effort of workers. Or it may be equally a decline in the quality of the machines, or the land, or the fuels with which labor works, so that less output is forthcoming for a given labor input. But the cause must, by mathematical definition, reside in one of these two sources. For researchers, therefore, the problem is to identify the specific culprits and to measure each one's contribution. And for policy makers, the problem is equally well-determined. Just as a decline in factor quality must be the cause, improvements in factor quality must be the cure.

Until quite recently, neither party took this simple mathematics seriously. Reagan Republicans talked about productivity, but emphasized cures -- from Kemp-Roth to capital gains -- that always coincided with the tax agendas of their rich friends. Claims that these policies work accompany arguments that we need more tax cuts for the same clientele. And Brookings Democrats, until recently the dominant strain, emphasized sound budget policies and higher rates of savings and investment, despite the lack of evidence connecting these instruments to the productivity slowdown.

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Now, an emerging third view does emphasize the importance of factors of production: the quality of labor and capital, the mechanisms for bringing them together, the level and quality of research and development, and infrastructure outlays as well as the supply of savings. Those who hold this view are just as passionate about the key role of productivity as are their Reaganite or Brookings colleagues. As William Baumol and associates have written: 'Tor real economic miracles one must look to productivity growth. And economic miracles it has indeed provided." Or as Paul Krugman writes, "Productivity isn't everything, but in the long run it is almost everything." Since Krugman teaches at MIT and Baumol's new book, Productivity and American Leadership, is published by the MIT Press, I shall call this the "MIT View." Yet another MIT product associated with this view is Made in America, the widely publicized 1989 Report of the MIT Commission on Productivity.

The MIT view underpins a new political agenda of the broad liberal center. The conclusions of Governor Mario Cuomo's competitiveness commission were close to MIT's. To judge from George Bush's State of the Union address, which calls for "investment in America's future -- in children, education, infrastructure, space and high technology," the President even holds some of the same beliefs.

The MIT view offers an appealing combination of fiscal rectitude and social compassion. Balanced budgets are good things, it argues. But if we are prepared to tax ourselves, or cut the military, or cut "entitlements," we can and should spend more on education, roads, bridges, housing, and scientific research. So long as they do not come at the expense of private saving, these investments will work to cure our productivity deficit and to close the productivity growth gap between ourselves and the Germans, the Japanese, and the newly industrializing countries. Faster productivity growth will cure our competitiveness problem, restore our trade balance, end the sell-off of our national assets, and permit sustained real growth of, say, 3 percent per year or better without inflation. Not bad work -- if you can get it.

Eclectic, not especially ideological, based on a coherent and comprehensible argument, the MIT view offers refreshing relief from the stagnant passivity of the Brookings Democracy on policy matters. For these reasons, and others, it is now ascendant, especially in the Democratic Party. But is it right? I am skeptical, and this article suggests several reasons why policy makers should worry when economists come to a policy consensus about issues that they themselves admit they do not understand. I propose instead to look at distinct industrial sectors, and to find therein alternative ways of understanding productivity and arriving at policy remedies. I also want to hone an argument over the particular interventionist policies that the MIT view suggests.

Limits of the MTT View
The MIT view shares with the Brookings view the conviction that productivity growth has declined. Efforts to find the undetected declines in the quality of our inputs have been extensive -- to locate the absenteeism, alcoholism, sloth, accelerated or energy-induced obsolescence of machinery, to measure the paper entrepreneurialism, short-focused management, the collapse of innovation, the resources wasted in mergers, acquisitions, Liar's Poker, golden parachutes, poison pills and what-have-you. But they have not succeeded. Edward Denison, the most systematic and persistent researcher on productivity, wrote in 1979, "What happened, to be blunt, is a mystery." In 1990 Paul Krugman summed up the progress since then: "Why did it happen? And what can we do about it? The answer to both is the same: We don't know."

Agnosticism on this point, indeed, is now ingrained in the economics profession, to the point where many who were once fascinated by the productivity phenomenon have now given up hope that a coherent explanation will ever emerge. Even if some new and compelling explanation were now offered, it seems unlikely that it could be accepted. Orthodoxy itself would be at stake; too many high authorities in our discipline have decided, to their own satisfaction, that the problem cannot be solved. But might the observations themselves be wrong? There are enough weaknesses in the mainstream treatment of productivity growth to warrant at least raising the question.

To begin with, the MIT view stresses the long-run character of the productivity problem. Baumol begins his new book with a chapter entitled "Why the Long Run?" Krugman similarly opens his discussion with a figure showing the decline in productivity growth, decade by decade, since 1899 (see Figure 1).

The point of the emphasis on decade averages is, quite deliberately and without apology or even explanation, to call attention away from annual data, which might lead the naive observer to the believe that short-run phenomena -- the recession phases of the business cycle -- are really the source of the evil. Figure 2 illustrates how this impression might arise.

The figure shows that in the recession-free 1960s and from 1982 until the 1989 slowdown, output growth stayed comfortably ahead of the growth of labor hours. Is it possible that our problems in the 1970s and early 1980s were due to the four recessions between 1970 and 1982? Baumol, Krugman, and the economics establishment recoil from this possibility, but they do not confront it directly and do not offer, to my knowledge, any persuasive test that refutes it.

From a policy standpoint the short-run/ long-run issue is crucial. For if productivity declines are largely cyclical -- the result of increased fluctuations in economic output -- then the "supply-side" policy discussion of savings rates and literacy and even infrastructure fail as explanations. One might talk instead about the need for low and stable interest rates, and for an incomes policy to tie wage increases to real productivity growth, and of the "demand-side" effects of expanding public investment and the social welfare system, all of which were hallmarks of the policy that kept us free of recession from 1960 through 1970. And to be perfectly nonpartisan, one might also ask whether those Reagan deficits, which got us out of recession and productivity slump after 1982, were so bad after all. These are thoughts congenial to both left and right, but that the liberal mainstream, needless to say, does not like.

A second weakness turns up when the argument shifts away from the historical decline in U.S. productivity growth rates, to the low average rate of U.S. productivity growth in comparison with other industrial countries. Here the hard evidence, even from the best sources, takes a most uncomfortable turn.

Baumol and associates, using data compiled by Angus Maddison, make two discoveries. First, while U.S. productivity growth is assuredly low by world standards, it seems to have been low by world standards at least since 1880! One is entitled to wonder about the meaning of a statistic that speaks so ill of U.S. economic performance over the whole of the American century. Oddly enough, a low average rate of measured productivity growth does not necessarily entail a loss of trade competitiveness or technological leadership in world product markets. Baumol and associates find, to their surprise, that U.S. shares of the high technology markets -- those industries where productivity growth is crucial -- have been rising, not falling, for the last decade.

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