Five facts about productivity

Global labor productivity is not slowing down; but it is slowing down, in many countries.

I have been playing with the labor productivity statistics from the Conference Board's Total Economy Database. Labor productivity is defined as real, PPP-adjusted GDP per person employed --using Geary-Khamis purchasing power parities. (Output per hour would be better, but many developing countries don't have data on hours.)

I smoothed the time series, country by country, using the Hodrick-Prescott filter (smoothing parameter = 100). The last data point available in the dataset is for 2013, but the last data point I use is 2010, to mitigate the end-point problem of one-sided filters such as Hodrick-Prescott.

The impression I have received lately is that productivity has stagnated or declined, but all the evidence seems to come from the U.S. or Western Europe. So the first thing I wanted to know is: Has labor productivity growth, for the world as a whole, declined?

This chart reveals Fact #1: World productivity growth has not slowed down significantly. Actually, average productivity growth was faster in 2000-2010 than in 1990-2000, although year-to-year growth seems to have plateaued in the second half of 2000-2010.

The chart shows the year-to-year growth of labor productivity growth. Each regional composite is constructed as the weighted average of country productivity growth, using the levels of real, total GDP as weights.

But both within developed markets and emerging markets output per worker is not growing as much as it used to. Among rich countries the deceleration is noticeable to the naked eye since the early 2000s, whereas in poorer nations the slowdown started in the mid-2000s.

This (superficial) paradox is possible, of course, because the share of emerging markets in world output has risen. So, Fact #2: World productivity growth has managed to stay constant through the 2000s because more and more output comes from emerging economies, where the level of productivity growth is higher. 

Next I compare the growth of productivity of two adjacent decades: 1990-2000 and 2000-2010. This map shows the change of (the geometric average of) productivity growth from one decade to the next. Green means an acceleration of productivity. The more intense the shade of green, the larger the increase of productivity growth. Shades of orange and red indicate a decrease of productivity growth. (Click here to see a bigger map, with values.)

The map shows the change in average productivity growth, by country, from 1990-2000 to 2000-2010. Source: Total Economy Database, author's calculations, http://gunnmap.herokuapp.com/.

The time series are here:

The chart shows the year-to-year growth of labor productivity growth. Each regional composite is constructed as the weighted average of country productivity growth, using as weights the levels of real, total GDP.

The chart shows the year-to-year growth of labor productivity growth. Each regional composite is constructed as the weighted average of country productivity growth, using as weights the levels of real, total GDP.

The map and the time series reveal the (largely expected) Fact #3: From one decade to the next, productivity accelerated in every major emerging region, and slowed down in every major advanced region. 

The Asiaphoria paper by Lant Pritchett and Larry Summers  made a lot of noise a while ago. In it the authors show that growth is not persistent in the long run: higher-than-average GDP growth in one decade tends to be followed by lower-than-average growth in the next. I wanted to know whether, from a casual observation of the data, that finding holds true for labor productivity, over the past two decades. On the following chart, the vertical (horizontal) axis shows the difference between country-specific productivity growth and the world productivity growth in 2000-2010 (1990-2000).

The chart shows, in the vertical axis, the difference between a country average productivity growth in 2000-2010 and the world average productivity growth in the same period. The readings along the horizontal axis are analogously defined. 

There is no correlation. If a country's productivity grows faster than the global average in one decade, that tells us nothing about excess productivity the next decade. If, instead, we look at excess productivity within advanced and emerging economies, the picture changes a little:

The chart shows, in the vertical axis, the difference between a country average productivity growth in 2000-2010 and the average productivity growth among advanced economies, in the same period. The readings along the horizontal axis are analogously defined. 

The chart shows, in the vertical axis, the difference between a country average productivity growth in 2000-2010 and the average productivity growth among developing economies, in the same period. The readings along the horizontal axis are analogously defined.

Productivity growth is in fact persistent within advanced economies, but there is no sign of persistence or reversion to the mean within emerging economies.

And so we have Fact #4: Within emerging economies, there is no significant persistence or reversion-to-trend of productivity growth in the long run. Within advanced economies, there is some evidence of persistent productivity growth.

Finally, I wanted to see if there appears to be unconditional convergence in productivity. This chart shows the average growth of productivity in 1990-2010 vs. the level of productivity in 1990. Unconditionally on stage of development, there is little relationship between level of productivity and subsequent productivity growth. But there are differences conditional on stage of development.

The chart shows, in the vertical axis, the average productivity growth in 1990-2010. The horizontal axis displays the log of the level of productivity in 1990. 

The chart shows, in the vertical axis, the average productivity growth in 1990-2010. The horizontal axis displays the log of the level of productivity in 1990. 

The chart shows, in the vertical axis, the average productivity growth in 1990-2010. The horizontal axis displays the log of the level of productivity in 1990. 

And that leads me to Fact #5: Within advanced economies there seems to be productivity convergence over the period 1990-2010. That's not the case, however, for developing economies.

Sundry links

No time for writing this week, so I'm listing blog posts and articles that caught my eye recently:

1. Liftoff levers. John Cochrane is doing a fantastic job explaining how the Fed's reverse repo operations are supposed to work. Start with this post, and then read this other one.

2. A "new" working paper, by Katharina Knoll, Mortiz Schularick, and Thomas Steger, looks at global house prices in the really long run (1870-2012). From the abstract:

...house prices in most industrial economies stayed constant in real terms from the 19th to the mid-20th century, but rose sharply in recent decades. Land prices, not construction costs, hold the key to understanding the trajectory of house prices in the long-run. Residential land prices have surged in the second half of the 20th century, but did not increase meaningfully before. We argue that before World War II dramatic reductions in transport costs expanded the supply of land and suppressed land prices. Since the mid-20th century, comparably large land-augmenting reductions in transport costs no longer occurred. Increased regulations on land use further inhibited the utilization of additional land...

3. An Icelander goes to Cyprus and tells us why Cypriots keep cash worth 6% of GDP under the mattress.--Sigrún Davíðsdótti at A Fistful of Euros.

4. China's monetary and exchange rate framework under pressure.

           4.1 Huge FX inflows turn into small outflows, and the PBoC switches from draining renminbis to injecting them. To keep base money growing, the central bank has introduced new tools. By Gabriel Wildau for the Financial Times.

           4.2 Time to ditch the renminbi-dollar peg? The Chinese currency has depreciated and is hitting the central bank's target band.

           4.3 On the internationalization of the RMB, a colleague forwards several papers and reports
                 Paths to a reserve currency, at the Asian Development Bank Institute.
                 The rise of the redback, by HSBC.
                 Yuan is fifth world's payments currency, at the WSJ.
               
An important event to keep in mind is that the IMF is reviewing the SDR basket in 2015. China is under pressure to step up the internationalization of the renminbi, ahead of the basket review.

5. Dani Rodrik summarizes the results of his latest paper on de-industrialization.

Premature deindustrialization is not good news for developing nations. It blocks off the main avenue of rapid economic convergence in low‐income settings, the shift of workers from the countryside to urban factories where their productivity tends to be much higher.

Industrialization contributes to growth both because of this reallocation effect and because manufacturing tends to experience relatively stronger productivity growth over the medium to longer term. In fact, organized, formal manufacturing appears to exhibit unconditional convergence (Rodrik 2013), which makes it special and an engine of growth. Since low‐income countries tend to start with small manufacturing sectors, the dynamic within manufacturing initially plays a small role, overshadowed by the reallocation effect. But over time, the within‐manufacturing effect becomes a more potent force as the manufacturing sector becomes larger.Premature deindustrialization throws sand in the wheels of both engines (Rodrik 2013, 2014).

The consequences are already visible in the developing world. In Latin America, as manufacturing has shrunk informality has grown and economy‐wide productivity has suffered. In Africa, urban migrants are crowding into petty services instead of manufacturing, and despite growing Chinese investment there are as yet few signs of a real resurgence in industry. Where growth occurs, it is driven largely by capital inflows, transfers, or commodity booms, raising questions about its sustainability.  

In the absence of sizable manufacturing industries, these economies will need to discover new growth models. One possibility is services‐led growth. Many services, such as IT and finance, are high productivity and tradable, and could play the escalator role that manufacturing has traditionally played. However, these service industries are typically highly skill‐intensive, and do not have the capacity to absorb – as manufacturing did – the type of labor that low‐ and middle‐income economies have in abundance. The bulk of other services suffer from two shortcomings. Either they are technologically not very dynamic. Or they are non‐tradable, which means that their ability to expand rapidly is constrained by incomes (and hence productivity) in the rest of the economy.

I couldn't help but tie Rodrik's paper to that other paper by Pritchett and Summers, the one about regression to the mean of long-term growth rates. Growth is far from a uniform process. It tends to happen in fits and starts. Those who are projecting high growth rates of developing economies, based on past high growth rates, which in turn hinged on industralization, are probably going to be disappointed.

6. The translation industry.The Economist opines that translation is very hard for machines. Humans will need to stay involved, but technology will improve productivity.

A different question: Do improvements in translation bode well for language diversity in the world? How about the language learning industry? I see this as a race between technologies that allow machines to translate better, and technologies that allow humans to learn languages faster. The machines are winning, by a long shot. We're clearly on a path to better simultaneous translation capabilities. Soon we'll be able to listen to anything, anywhere in our native tongue, in real time. That means humans won't have to know more than one language. Learning languages will become a hobby, like dancing. (Sorry, parents, but you're wasting your money on Mandarin lessons.)

As for language diversity, I think a more important force than technology is urbanization. The lion's share of the world's languages are spoken by small, rural communities in developing countries. Urbanization increases the usefulness of majority languages, killing the minority languages. And urbanization will happen faster than the spread of cheap, simultaneous translation technology. At some point, however, the trend towards fewer and fewer languages will slow down, as simultaneous translation becomes pervasive.

Africa's unlikely rise*

Africa had it good for ten years. Income per person adjusted for inflation, which declined in the 1980s and 1990s, rose almost 30% between 2000 and 2010. In Ethiopia and Angola real average income doubled—after zero growth in the previous twenty years. Glitzy shops and skyscrapers have replaced drab neighborhoods, and new millionaires have sprouted out of nowhere. A single decade has seen the continent go from basket case to basking in the narrative of “Africa Rising.”

Africa owes its growth spurt to a windfall of high commodity prices and low interest rates. China alone has changed the fortune of the entire continent, buying increasing amounts of natural resources, providing cheap loans, and stimulating foreign direct investment. But the manna is running out.

China won’t grow at 7% per year forever. The recent surges of credit, capital spending, and housing prices are simply unsustainable. Aging will soon catch up to the Red Dragon, after decades of one-child policy. Plain mean reversion, according to a new paper by Lant Pritchett and Larry Summers, will lower China’s and India’s average growth to 3% or 4%. Even a growth rate between 4% and 7%, as most forecasters project, would imply a sharp slowdown for African exports, compared with the roaring 2000s.

Africa has already felt the bite. Oil prices crashed in 2009 and, despite a partial rebound through 2011, they’ve been overall flat since then. A sluggish global recovery means that African oil production dwindled to 9.3 million barrels per day in 2013 from 10.7 million in 2010. The GSCI precious metals index has fallen 20% since 2011. The prices of cash crops such as cotton, coffee, and cocoa are all lower than four years ago. GDP growth, naturally, has suffered: sub-Saharan Africa’s has slowed to 5.1% this year from 6.9% in 2010, according to the International Monetary Fund.

Restarting the commodity boom doesn’t guarantee Africa’s success. In resource-led economies manufacturing tends to shrivel. Mining hogs capital. Foreign purchases of commodities push up the 

exchange rate, which  raises the foreign price of  goods and renders domestic firms uncompetitive. Labor goes under-utilized, since digging and drilling employ few bodies. The gains from mining wind up in the hands of a minority, failing to create a broad base for domestic demand.

Structural change in reverse

The normal engine of development is industrialization. Almost every large country that has become rich has, along the way, industrialized. That’s what happened in 19th-century England, early 20th-century North America, post-war peripheral Europe, and Asia-Pacific. It’s not an economic law that a country must industrialize to become rich, but history shows that other paths are seldom walked.

Industrialization drives development because labor moves from low-productivity jobs (typically in agriculture) to high-productivity ones. Even if output per hour is stagnant within sectors, simply shifting workers to the more productive uses raises total growth.

But Africa, it turns out, is de-industrializing. Manufacturing is now smaller as a share of GDP than in 1974 (Exhibit 1). Fewer than 8% of workers toil in a factory making goods, and the number is falling.In sub-Saharan Africa, between 1990 and 2005, workers seem to have shifted towards lower-productivity jobs. That retrogression lowered growth by 1.3 percentage points per year, according to a 2011 paper by Margaret McMillan and Dani Rodrik. Shifting workers to high productivity jobs, by contrast, lifted Asia’s rate of growth by 0.6 points.

Exhibit 1

Globalization  may be to blame. In Japan, Korea, and China, international trade fostered progress. Modern technologies were adopted; power lines and railroads were laid out; rural workers left the field for the factory.

In sub-Saharan Africa, however, globalization had the opposite effect. Dani Rodrik, a leading development economist, has argued that competition wiped out many African firms, while the rest had to downsize. Nigeria’s garment industry couldn’t compete with Chinese textiles; South Africa’s industry withered during the 1990s, just as Asia’s was rising.

Foreign competition may have even lowered productivity. Rodrik thinks some of the surviving factories went underground. As a result, many African goods are made in illicit sweatshops, which have little access to capital and produce low-tech goods.

Most of the redundant factory hands, however, found work in services, mostly informal. Almost 80% of working people in sub-Saharan Africa have “vulnerable” jobs—meaning, as defined by the International Labor Organization, that they’re self-employed or contribute to the family business. Raising human capital under those conditions is difficult.

The sad upshot is that, even in periods of strong global growth, like 2001–2007, Africa falls further and further behind the world’s productivity frontier. In 1997 Angola’s output per worker was about half of China’s, adjusted for purchasing power parity. Ten years later, despite stellar growth, the ratio was ten percentage points lower. In Mozambique, another fast-rising country, relative  productivity fell to 52% from 72%.

A second chance?

Can Africa rekindle industrialization? Many analysts will tell you that “institutional factors” get in the way. Red tape, legal insecurity, and poor infrastructure discourage investment. Every year African countries fill the bottom rungs of “ease of doing business” rankings. Pervasive corruption doesn’t help.

But that’s not what’s holding back Africa. Industrialization and ease-of-doing-business are, after all, a chicken-or-egg problem: countries don’t get more business friendly before they get richer. Plus, Asian manufacturing thrived amid lax law enforcement and rickety infrastructure.

Rodrik puts his finger on several items that may actually decide the fate of African industry. The first one is the exchange rate. Angolan goods might compete with Malaysian exports— if only the kwanza  was cheap enough. An undervalued currency is a subsidy on tradable-good industries, and offsets the difficulty of doing business. The right mix of fiscal and monetary policy would achieve a competitive exchange rate.

A second thing policymakers can do is unshackle the labor market. McMillan and Rodrik find evidence that countries with flexible labor markets experience productivity-raising development.

On the other hand, some hurdles to progress are beyond the policymakers’ reach. One handicap is the aforementioned curse of natural resources, which suck the life out of manufacturing. Another obstacle is that industrialization is getting harder for everyone.

In a recent article for the Milken Institute Review, Rodrik says that when manufacturing peaked in Britain and Germany it employed nearly a third of the labor force. Korea’s industry never topped a 30% share. India and Latin America have recently peaked at less than 20%. Most strikingly is that in countries that are hardly rich or industrialized, such as Vietnam, manufacturing is already losing ground!

As the global demand for goods declines relative to services, competition among the world’s factories will get stiffer. In those circumstances African producers will have a tough time carving market share away from Chinese or Mexican manufacturers. Besides, labor-saving technology means that factories need fewer and fewer workers.

Alternatives

Would services lead growth instead? Tradable services seem a nonstarter. Most exportable, high-productivity services are delivered by highly educated people, Rodrik notes. Services like programming, engineering, medical diagnosis, and finance call for advanced degrees, on which the continent is short. Africa is unlikely to be the next India, which is leaping from a rural to a services-based economy.

Many non-tradable services in Africa today—retail, personal services, transportation—can be performed by relatively unskilled people. The problem here is demand. For all the talk of soaring income per capita, 70% of sub-Saharan Africa still lives on less than $2 a day. The natural resource boon has blessed a thin minority, typically connected to mining, construction, government, or all of the above. Among the vast majority, few hold a formal, salaried job. Lacking steady, adequate earnings, consumers won’t spend much on services—or on anything else. 

What future, then, awaits Africa? Two scenarios are possible. One, the continent keeps growing, but falls short of an economic revolution. Industrialization doesn’t jell, and Africa’s lot improves through a mix of resource exports and a mild rise of overall productivity, while falling further behind the world’s economic frontier.

In the alternative scenario, Africa does have a growth miracle, by adopting a development model that we’ve never seen before. Somehow,  by using new technologies or providing yet-unimagined goods and services on which Africa holds still-unknown comparative advantages, the continent catapults itself to high-income status. It's a stretch of the imagination for me, but never underestimate human creativity.

References

McMillan, Margaret and Dani Rodrik (2011), “Globalization,structural change, and productivity growth,” NBER Working Paper #17143.

Pritchett, Lant, and Larry Summers (2014), “Asiaphoria meetregression to the mean,” NBER Working   Paper #20573.

Rodrik, Dani (2014), “Why an African growth miracle isunlikely,” The Milken Institute Review, Fourth Quarter 2014.

*This is an edited version of an article I wrote for the Dec/Jan issue of Morningstar magazine, my employer's publication.

Latitude, fertility, and economic development

Dietrich Vollrath comments on a paper by economists Holger Strulik and Carl-Johan Dalgaard, on the relationship between geographic latitude and economic development. I found it fascinating to follow the entire reasoning chain.

He starts with the striking observation that the relationship between latitude and development (measured here as population density or urbanization rate) has reversed over time. In year 2000, the further a country is from the equator, the richer it is; but in year 1500, it was the opposite: Mediterranean countries were wealthier than their northerly neighbors.

To explain this change, Dalgaard and Strulik use the Bergmann's Rule. In Vollrath's words:

Bergmann’s rule states that average body mass of organisms rises as they get farther from the equator. This holds for people as well as animals. People generally have higher body mass farther from the equator.

Bergmann's rule is due to biological reasons. Having a small surface area-to-mass ratio is good in cold climates, because it means you lose less body heat. So in high latitudes it's good to have large bodies (small body surface relative to weight), while near the equator it's the opposite.

Big bodies also need a lot of calories, and pregnant women need even more calories. Given a supply of food, women in higher latitudes were forced to have fewer babies, so populations were smaller. (All this is prior to the Industrial Revolution.) So in Southern Europe populations were larger, which also meant, "in almost any type of growth model you write down," more innovation. More innovation, voilà, means wealthier people.

Eventually, the argument goes, the northern countries catch up on innovation, to the point where it makes sense to invest more on human capital. They were already having few children, so investing more in education, etc., per kid, comes naturally. Average human capital is higher, they become more adept at using human capital-intensive technology, and they become wealthier than the southern countries (vice versa in the southern hemisphere). The loop between development, fertility, and human capital investment reinforces itself, and the high latitude countries start the demographic transition earlier than their tropical counterparts.

I don't know enough about biology--or development economics--to add much here. My prior is that cultural reasons exert great influence on fertility, creating demographic inertia, and working against the type of "structural change" that inverts the relationship between latitude and development. And how about government policy? France has a significantly higher fertility rate than Spain or Italy.