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.

Growth and productivity in developed countries: the 2007-13 record

A recent post by Antonio Fatás got me curious about the composition of growth between 2007 and 2013. (Beware, however, that the period doesn't comprise a full business cycle, and that some European economies suffered two recessions during that period.)

Antonio shows that, between 2007 and 2013, the growth of productivity -measured as GDP per worker- was strongest in Spain, U.S., and Ireland. (I don't know where his data come from, so I make no attempt to replicate, correct, or comment on his findings.)

I look at data on the decomposition of growth from the Conference Board's Total Economy Database (TED). I start with the (geometric) average growth rate of GDP:

Australia, Switzerland, Canada, and the U.S. posted the fastest growth, whereas the GIPS were the weakest.

How was growth split between the increases in labor quantity and labor productivity?

Once again, the GIPS shed the most labor, whereas Australia, Switzerland, Norway, and Canada added the most. (Notice that three of the top four are commodity economies.) In the U.S. total labor input decreased between 2007 and 2013 (although much less than in the GIPS).

On productivity, Australia is still among the top performers, and so is Canada. But here the news is that two of the GIPS (Ireland and Spain) are near the top, along with the U.S. In Italy and Greece productivity declines sharply, and so does in the U.K. This feature of the U.K. recovery (relatively small job loss, and massive declines in productivity) has been covered several times by the FT.

Productivity growth can further be decomposed into the contributions of: changes in labor composition (essentially, changes in the education of the employed), capital additions, and "dark matter" (also known as total factor productivity).

Starting with labor composition:

Portugal, Greece, and Spain improved the quality of their employed the most, whereas Italy did so the least. The labor composition didn't make a negative contribution to growth anywhere.

The contribution of capital (the sum of ICT and non-ICT capital) was also positive in every country, and was largest among commodity economies, as well as Ireland. Greece here is number six. Italy is once again last.

Finally, and strikingly, total factor productivity growth was negative almost everywhere:

TFP contributed the most to growth in some of the richest economies (U.S., Japan, Germany, Switzerland) and the least in Greece, Norway, U.K., and Portugal.

To sum up:

1) Output growth was fastest among commodity economies (Australia and Canada), as well as the U.S. and Switzerland, thanks to generally growing labor input (or a small loss, in the U.S.), fast growth of capital, and some growth of TFP in the U.S.

2) Labor composition (the "quality" of labor) added to growth everywhere, whereas total factor productivity was negative everywhere except in the U.S. and Japan.

3) Southern European countries lost the most employment.

4) Productivity shrunk by a massive amount in Greece. Italy, the U.K., and the Netherlands also saw their productivity decline.

Fear depression, not deflation

Following up on a blog post by David Andolfatto, I checked on the deflationary experiences of seven countries during the 19th and 20th centuries.

The mainstream commentary these days is that deflation causes (or at least is associated with) declining real economic activity. Here's an example of this type of narrative:

Plenty of people are alarmed by the prospect of deflation, which can snuff out growth by making consumers reluctant to spend and companies unwilling to invest.

David's main point is that that's not always the case. Both the U.S. after the Civil War, and Japan since 2009, experienced declining price levels, but real GDP per capita rose.

I have put together a dataset of price indexes and growth between 1828 and 2006 for Australia, France, Netherlands, Spain, Sweden, U.S., and U.K. (Many thanks to the sources, especially measuringworth.com, and the International Institute of Social History, for distributing the data for free!)

It's relatively well known that prices were roughly steady in the 19th century, although income per capita rose quite a lot. The inflection point seems to be the Great War, but that's something I learned only after looking at the data.

See these charts and table:

This seems hard to reconcile with the conventional association between "lack of inflation" and "lack of growth."

Taking five-year growth rates, the association between inflation and real growth is hard to spot (the picture is very similar with one-year growth rates):

Finding "big" deflations

Ok, maybe you're thinking: 19th-century deflation was slow and steady. Under that type of deflation, declining prices are presumably expected, which should be less damaging than rapid, unexpected deflation.

To which I reply: But slow-and-steady is the kind of deflation that we're contemplating these days, right?

How about abrupt, big deflations? I don't know of a definition of "big" deflation, but I think most people have the American Great Depression in mind.

The U.S. price index bottomed in 1933, at which time the five-year, annualized inflation rate was -5.4%. So I have looked for deflations of this size across countries. When I find one, for a given country, I rule that a "big" deflation episode occurred, starting with the first year in which one-year inflation was negative, and ending with the first year in which prices rose (even if the five-year inflation rate was no longer below -5%). If the string of price declines is interrupted for only one year, I consider the episode of deflation was unbroken; if the string stops for two or more years (and five-year inflation eventually falls below -5%), then a new episode begins.

Using this admittedly ad hoc process, I find the following episodes of "big" deflation:

The table shows that, for example, Australian prices fell at a compounded rate of 3.6% a year between 1836 and 1851, for a total decline of 43%. Real GDP per capita went up by 5% a year.

Except for the deflations in the late 1920/early 1930s, output per capita didn't fall during deflations! It has been possible, and in fact frequent, to have rising real economic activity and falling prices, even with rapid deflation.

At the very least, I think we should agree that not all deflations are created equal. Only a small minority is associated with persistently declining real activity. And those experiences, over the last two centuries, have all happened during a peculiar period (the Great Depression).

What really hurts, then, is not deflation, but a depression, which is not what most people expect for the years ahead.

Data sources:

Real GDP per capita growth:

Maddison Project Database.

Inflation:

Australia: Diane Hutchinson
France: CGEDD
Netherlands: International Institute of Social History
Spain: Rafael Barquín Gil, Esmeralda Ballesteros, and Jordi Maluquer de Motes.
Sweden: Riksbank
United States: Lawrence H. Officer and Samuel H. Williamson
United Kingdom: Gregory Clark

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UPDATE (2/15/2015): I just came across this paper, which does the empirical analysis I had in mind:

Atkeson, Andrew, and Patrick J. Kehoe. 2004. "Deflation and Depression: Is There an Empirical Link?" American Economic Review, 94(2): 99-103. Ungated version here.

And here's another paper, by Jess Benhabib and Mark Spiegel, with different conclusions.
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Long-term growth trends

Gavyn Davies brings our attention to a paper (by Juan Antolín-Díaz, Thomas Drechsel, and Ivan Petrella), on the changing long-trend of GDP growth in G-7 countries. Here's the paper, here's a non-technical summary, and here are Davies' comments.

Trend growth rates have declined massively over the past 50 years. The authors do perform structural break tests, but I'm not sure whether one can conclusively say that there is a break in the series, rather than the alternative hypothesis that the change is gradual.

Either way, the figures are impressive (or depressing):

From Davies' column (emphasis mine):

The results show an extremely persistent slowdown in long run growth rates since the 1970s, not a sudden decline after 2008.

[...]

Averaged across the G7, the slowdown can be traced to trend declines in both population growth and (especially) labour productivity growth, which together have resulted in a halving in long run GDP growth from over 4 per cent in 1970 to 2 per cent now.
Some version of secular stagnation does seem to be taking hold. This may partly explain why, for the last five years, forecasts of G7 real GDP growth have been persistently biased upwards.

[...]

The regression to the mean that Summers/Pritchett have identified is a reversion to the global average growth rate. But that growth rate may also change. The assumption that the mean growth rate is one of the great economic constants in advanced economies is simply wrong.

[...]

The slowdown in long run growth in the developed economies therefore seems to have become a permanent fact of life, rather than a temporary result of the financial crash that will disappear over time. But the actual path for GDP has fallen well below even the depressed long run equilibrium path since 2009.

On the assumption that growth is a constant, I would say that virtually every analyst recognizes that there's been a growth slowdown, relative to the 1970s. I think the more common mistake is to extrapolate from recent growth rates to forecast long-term growth (for example, assuming the U.S. long-term growth rate is 2% or 2.5%). Without a theory of what has depressed productivity (for example) since the 1970s, or since the early 2000s, how useful are those long-term forecasts?

In the last quoted paragraph I don't think "equilibrium" is the best word. This is purely econometric work, so I don't know what notion of "equilibrium" this even corresponds to.

Finally, take the tail end of the charts (say, the last ten years) with a grain of salt. I think the trend estimate at any point in time should be informed by both past and future data. Recent trend estimates might be biased by data from the current business cycle--especially the recent deep recession, and current (possibly abnormal) recovery.

Still, I think the broad findings are important.

What caught my eye

1. Benjamin Friedman describes the perils of downsizing the central bank's balance sheet. It wasn't my first guess, though. Friedman argues that, by holding an assortment of assets, central banks have acquired a new tool to fine-tune monetary policy.

2. A three-part essay on alternative measures of inflation, on the website of the Atlanta Fed, by Mike Bryan, the father of the trimmed CPI and the median CPI.

3. Australia proposes to raise the retirement age to... 70! (on Bloomberg)

4. Excellent review of the consensus view why the "natural" interest rate has tumbled, by Larry Summers (via John Cochrane).

5. The TIOBE index: the most popular programming languages.

6. A comparison of programming languages in economics, by Aruoba and Fernández-Villaverde, from this week's batch of NBER working papers.

7. Can productivity rise forever? A partial discussion of the main issues, by Robin Harding at the FT.

8. Repeat after me: banks do not "lend out" reserves, by Paul Sheard at S&P, via David Andolfatto. David commented on Sheard's note, and was quickly corrected by Nick Rowe. David has now written a simple model to think through the issue of excess reserves and inflation risk. Don't you love economics blogs??

20130606 Links

1. Top ten contributors to global growth; 2. Reorienting China; 3. Will India get downgraded to junk status?

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1. Emerging and developing economies already make up about 50% of the world's GDP at purchasing power parity. Their large size, and continued higher rates of growth than in advanced economies, have catapulted EMs to the top of the chart of main contributors to world growth. For the period 2012-17, the top contributors to world GDP growth are projected to be (in brackets, rank in 2002-07):

1. China (1)

2. U.S. (2)

3. India (3)

4. Russia (4)

5. Brazil (6)

6. Indonesia (11)

7. South Korea (9)

8. Mexico (10)

9. Japan (5)

10. Turkey (8)

Canada and U.K., which were in the top ten in 2002-07, get dropped.

Source: Financial Times, accessed on June 5, 2013.

2. IMF paper by Lee, Syed, and Xueyan on consumption and investment in China. Abstract:

This paper proposes a possible framework for identifying excessive investment. Based on this method, it finds evidence that some types of investment are becoming excessive in China, particularly in inland provinces. In these regions, private consumption has on average become more dependent on investment (rather than vice versa) and the impact is relatively short-lived, necessitating ever higher levels of investment to maintain economic activity. By contrast, private consumption has become more self-sustaining in coastal provinces, in large part because investment here tends to benefit household incomes more than corporates. If existing trends continue, valuable resources could be wasted at a time when China’s ability to finance investment is facing increasing constraints due to dwindling land, labor, and government resources and becoming more reliant on liquidity expansion, with attendant risks of financial instability and asset bubbles. Thus, investment should not be indiscriminately directed toward urbanization or industrialization of Western regions but shifted toward sectors with greater and more lasting spillovers to household income and consumption. In this context, investment in agriculture and services is found to be superior to that in manufacturing and real estate. Financial reform would facilitate such a reorientation, helping China to enhance capital efficiency and keep growth buoyant even as aggregate investment is lowered to sustainable levels.

I am not surprised that the authors find evidence of excessive investment, but the insight that private consumption is heavily dependent on investment in the western provinces is new to me. And this has an important implication: if eventually investment growth slows down, as almost certainly it will, total domestic demand will slow down, regardless of how much rebalancing occurs away from investment and towards consumption.

3. S&P revised India's outlook to 'negative' on April 25, 2012. Fitch did the same in June of the same year. Moody's keeps the outlook as 'stable.' All three major agencies give India the lowest of the investment-grade ratings: BBB- (Baa3 in the case of Moody's).

As key drivers of the revision and possible future downgrade, the analysts at S&P wrote in June 2012: "The outlook revision reflected at least a one-in-three chance of a downgrade in the next two years if India's external position continues to deteriorate, its GDP growth prospects diminish, or if progress on fiscal reforms remains slow." I was not able to read Fitch's report, but in an April 2013 interview of CNBC with Art Woo, the agency's director of sovereign ratings, he said it was more likely than not that India would be downgraded, citing slower growth and the deterioration of public finances.

The odds are against India, I'm afraid. Since 2012:Q1, GDP growth has slowed further, the current account deficit has become wider, and the government deficit has shrunk only marginally. The IMF projects GDP growth (p. 153) to rise from 2012 to 2013, but so far we have not seen this improvement. The IMF also projects the government primary deficit to shrink marginally in 2013, but the total deficit to remain unchanged, as a % of GDP. The current account balance, at -4.1% over the 12 months to 2012:Q1, has declined to -5.1% as of 2012:Q4. And, although there are some big changes underway, but I get a sense that the latest wave of reform will amount to a marginal change, rather than a Big Bang, as it has been dubbed.

In my opinion, the most likely scenario is: at least one agency downgrades India by the end of 2013. Second most likely scenario: the downgrade happens in 2014.