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Productivity Predicts Happy Days Ain’t Here Again


If you look at long term unemployment, the recession of the mid 1970’s had an interesting feature: some jobs never came back. The economy down shifted to a state of higher structural unemployment. This sort of thing should, in neo-classical theory, result in an immediate reduction in wages until unemployment reaches equilibrium. This, did not happen. Instead the jobs that were lost in that recession never came back, and with it was broken the relationship between profitability and wages. Workers were more productive, but did not see any of this in their pay envelopes.

About two years ago, it was obvious that there was too much leverage in bad debt, however the stomach for a remedy wasn’t there under Bush, and now the size of that remedy is astronomical. There are, in all probability more than $4 trillion in bad assets, many of which are toxic—that is, the best that can happen is that they expire worthless. Hence, hokey pokey on bank plans on the road to japanification, and what Roubini calls "ZIRP"—or Zero Interest Rate Policy.

What is slowly filtering into the consciousness of the punditocracy, is that this downturn may well be the same: a permanent reduction in the demand for labor versus the people who want jobs. Bad news, of course, is not in short supply. Last week we got a drop in productivity, and a jobs report which can only be described as a "massacre." Retail sales probably fell. Even "Dr. Doom" has revised his economic numbers downward.

But what really worries people comes from a few simple questions. The first is the intractability of the credit crisis. Basically, matters have to get worse, because no one is willing to accept taking the kind of haircut—as economists put it—that comes with fixing it. The second, however, is productivity. This is because anything you want to do, from health care, to more bank fixes, has to come out of someplace. That means employing more people who make more things.

One can quibble with the true utility of productivity, that is GDP per worker hour, but if the question is how much can be produced to give to people who have deferred consumption then productivity is the measure. You know, stuff we are going to sell to Arabs and Chinese workers who put off consuming now, so they could consume later. Every act of borrowing is a bet you can pay off with tomorrow’s cheaper dollars, or tomorrow’s more productive labor. The borrower, however, merely needs to do better, so it is possible for a win/win. However, it is also possible for a lose/win, or a lose/lose. Right now, that last case keeps staring us in the face.

If productivity is falling, however, that means fewer people will be hired, because the least valuable people are already being hired. Economists like to smooth out bouncy noise like this, to find the long-term trend. However, noise is often data. What this chart has in its data is several important points. One is that in the era when the American economy took bigger risks, that is, had quarters with large falls in productivity, it had bigger large gains, and higher average productivity. Then came a period with large falls, and the resolution—the Thatcher-Reagan era—was to use credit to smooth out the economy. This meant fewer big falls, but less average productivity than the golden age of liberalism.

The second point is that productivity comes in waves: big peaks signal that even ordinary quarters will rise. One can mathematically trace suspension bridges between the big peaks. That the little peaks are falling, tends to mean that productivity is going to keep falling. This is really bad, because for a period of economic uncertainty to end, there needs to be the expectation that there is money to be made. There needs to be, in a phrase, rising productivity. "Quantitative Easing" can’t produce productivity, it can only monetize government backing of debt, which, as we’ve seen, has to come out of someone’s wallet someplace, and the people with bottomless wallets aren’t interested in having a hole put in the bottom of them.

Right now, Obama’s economic team is banging their head against a catch-22: Until there is private money coming in, credit can’t be restored. Until there is rising productivity, private money has every reason to sit on the sidelines and by bonds to pay off eventual tax increases. Until credit is restored, there is no chance of rising productivity. And so it goes. It’s like waiting for Godot’s recovery.

I keep getting asked for a solution. That solution is simple—it’s just painful. There isn’t enough oil-based production left to pay back what has been borrowed. We are like people who took out a 30-year loan to buy a car, and then wrecked it after 10 years. We still owe 20 years of payments on a wrecked car. That means that claims on future oil have to be removed. It also means that we have to have things people want that fit within the production that can be done in the future. This isn’t windmills, it isn’t "green jobs" in the sense of green supply. This is because we aren’t facing a shock of energy supply, we are facing a shock of credit supply. What is needed then, is not green supply, but green demand, which will then generate green supply. In other words, find things people want with green production, and then draw them in.

This isn’t as strange as it sounds. In 1900, there was not automobile infrastructure. People who had the money for cars didn’t want the things that cars could get them. It wasn’t until people who did not have access to the luxury world of that time started getting cars, that what cars could bring people became obvious. The same can be said for steam engines, which existed for long before they revolutionized the economy. Steam entered the world in the 1760’s. But trains didn’t take over for a long time, and steam didn’t replace sail until almost a century after James Watt’s innovation.

Green demand then, is the problem. Find green demand, and people will devise ways of supplying it. But they have to be paid in money that more easily lets them buy other things of green demand, rather than oil money. The problem now is that the things that we supply that are green, such as education, are used to buy things that are black. We can’t launder green demand into black demand and have anything work.

But the people who have grease wealth, and the people who make them, and most especially the people who make the jet fighters who defend those goods, and the people who have a right to turn green demand into grease consumption, aren’t quite ready to go yet. So, that means we need another few quarters of pain before the Mitch McConnell’s of this world realize they have to work with the consensus for success—or they will get dragged down with everyone’s failure.

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