I have often written on these pages, in separate posts, about full employment and productivity growth. Today, I’d like to try to convince you of what I believe is a critically important linkage between these two mega-important economic concepts.
In recent years, slow productivity growth has surfaced as another fundamental problem throughout the “G-7” countries. This fact should disabuse you of some country-specific policy problem. It’s hard to blame our tax code, e.g., when this slowdown is occurring across all these different countries with very different tax regimes.
What do these economies all have in common? Their central unifying feature is weak demand: slow growth, high unemployment, weak job creation, low investment. Clearly, the U.S. is doing a lot better in terms of job growth and unemployment, but even 6.5 years into this expansion, we’re still not at full employment.
Okay, that’s a lot of throat clearing but we’ve arrived at the point of these scribblings: I think one reason productivity growth is slow is because of the absence of full employment. In other words, I think there’s an FEPM — a full-employment-productivity-multiplier. When there’s too much slack for too long, this multiplier drives down productivity; when we’re at full employment, the FEPM will cause productivity to speed up.
How could this be? Let me count the ways.
There is an economic assumption that firms are operating at their full productive capacity (the edge of their “production possibilities frontier” if you want to sound annoying). If that weren’t the case, so the assumption goes, their competitors, who are running at full efficiency, would compete them out of the market.
To which I say, look around. There are surely lots of firms failing to squeeze every available efficiency out of their production process. And yet, they live on. Many take the “low road,” paying lousy wages to their workers and not worrying about turnover or inefficient but cheap workers because it’s a buyers’ labor market. With enough slack in the job market, they’ve got an endless supply of cheap labor.
But what if that changed? What if stronger demand led to full employment? And what if that gave their workers enough bargaining power to push up labor costs? Then, to maintain their profit margins, these low roaders would have to find efficiency gains to offset their higher wage costs. Less turnover, for example. Less reason to hang onto extra workers who weren’t always needed but were cheap to have around. And this is a description of stronger demand leading to higher productivity.
A similar channel works on the investment side, as Peter Eavis nicely gets at here. Persistently low demand leads to low interest rates. Here’s what can happen next:
“… it is possible that the low interest rates have held back forces that would have made companies more efficient. [Economist Larry Summers recently] cited the experience of Japan, where interest rates have been low for a long time.
“In a period of zero interest rates or very low interest rates, it is very easy to roll over loans,” he said. “And therefore there is very little pressure to restructure inefficient or even zombie enterprises.”
By the way, another benefit of full employment is that it can also pull more people back into the job market, kick up our low labor force participation rate, and raise the economy’s growth rate, which is the sum of the growth rates of productivity and labor supply.
So, how do we get to full employment? I tried to draw the roadmap in my latest book (free online!), but in short: it will take a combination of monetary policy that weights job growth over inflation when the latter’s not a threat, fiscal policy that invests in public goods, a lower trade deficit (again, Fed rate hikes that strengthen the dollar hurt here as well), and direct job creation in parts of our country that even very low unemployment fails to reach.
Okay, but where’s my proof? Darn it, ya got me. This is not one of those pieces where I link to academic studies that have proved these connections. In fact, this sort of thing is really hard to prove using the usual data that I can load into my statistical software with a few clicks. Yes, productivity notably accelerated in the full employment 1990s and has petered out in the long period of slack since then. But that’s not proof. I suspect this will take case studies, international comparisons — basically, we’ll need a lot more variation than we can get out of the national statistics to prove the existence of the FEPM.
I think this is real, and frankly, there are not a lot of ideas around about how to juice productivity growth. But even if I’m wrong — hard to imagine, I know, but just go with me for a moment — we should still do everything we can to get to full employment. And if we get there and stay there, I suspect we’ll get the added benefit of tapping the FEPM.