The productivity puzzle

Labour productivity is falling. Today's figures show that total hours worked have risen 1.6% in the last year, whilst the NIESR estimates that GDP fell 0.2% in the time. GDP per hour is now 4.5% below 2007Q4's level. Had productivity continued to grow at its 1977-2007 rate, it would be 10.8% higher.

Now, some of the productivity shortfall reflects Q2's temporary Jubilee-induced drop in GDP. And maybe some of it is due to GDP being under-recorded and/or hours being over-recorded; there is, remember, considerable sampling error in the employment data.

But this cannot be the whole story. It cannot explain all of the 13.7% gap between where productivity is and where it would be, had past trend growth continued.

So, what can explain this? A strong candidate is labour hoarding (pdf); firms have been hanging onto workers in the hope (pdf) of an upturn in demand.

I don't deny that this is part of the story, maybe a large part. But three things make me doubt that it's the whole story.

1. Labour hoarding should be reversing now. Between 2007Q4 (the cyclical peak) and 2009Q3, GDP fell 7% whilst hours worked fell 3%. This tells us there was considerable labour hoarding in the early stage of the crisis.In a normal recession/recovery, this process would be unwinding now, as some firms enjoy rising production whilst others give up hope and cut staff. But it isn't happening. Since 2009Q3, GDP has grown 2.4% whilst hours have risen 2.8%.

2. Companies in aggregate want to pay off debt or raise cash. Why then should they be unusually keen to jeopardise cashflow by retaining staff?

3. If we were seeing labour hoarding in a weak economy, there should be a drop in the job separation rate and therefore a low level of unemployment, given the level of vacancies. But this doesn't seem to be happening. In the last 12 months, the change in unemployment has been pretty much what you'd expect, given the small rise in vacancies.

These doubts make me fear that something else is at work - that maybe there is a genuine productivity slowdown. Two things lend credence to this:

- One effect of the financial crisis is to starve new firms of the finance to expand. This retards the creative destruction which is key to productivity growth. A lot of this growth, remember, comes not from existing establishments increasing their efficiency, but from workplaces closing down and being replaced (pdf) by newer ones. Anything that slows this external restructuring is bad for productivity.

- Even before the crisis, firms were holding back on investment. This should lead to slower productivity growth. This is partly because it means workers are using less efficient capital; they spend their time cussing servers and printers rather than working. But it's also because a lack of investment is a symptom of pessimism about future growth - a pessimism which seems to be correct.

Now, I don't say this to dismiss labour hoarding or mismeasurement as possible explanations. All I'm saying is that the productivity puzzle is a deep one. And I'm not sure it has a happy solution.

Comments

[Luis Enrique]

What about my old hobby horse, the idea that in a services economy, investment doesn't show up as capital accumulation (i.e. it isn't recorded as investment in the data) but takes the form of hiring people to develop lines of business that aren't yet fully operational (i.e. producing). In which case phases on investment would look like phases of decreased labour productivity.

this is a very optimistic thought, probably wrong.

[pablopatito]

"firms have been hanging onto workers in the hope (pdf) of an upturn in demand."

I can tell you this is exactly what the company I work for is still doing.

"Companies in aggregate want to pay off debt or raise cash. Why then should they be unusually keen to jeopardise cashflow by retaining staff?"

I suspect small businesses are more reluctant to ditch staff for purely economic reasons. There's often an emotional attachment/bond between the firms' owners and their staff that makes sacking difficult, and thus more likely to be avoided.

[Shinsei1967]

What's the likelihood that the collapse in City financial activity has had a significant impact on national productivity numbers ?

[Account Deleted]

Point 1 assumes a symmetry between labour hoarding and the unwinding of that hoarding during a recovery, but it may well be the case that hoarding is "sticky", depending on the way it was implemented.

For example, if the hoarding took the form of management looking the other way, rather than vigorously driving down hours to match declining output, then it may find it difficult to wean staff off the now-established working patterns. It's easier to slow down than speed up.

Another possibility is that some companies deliberately invested in "special projects" for the duration of the recession, such as (finally) reorganising the filing system. This will produce a return, but that may not show up in productivity until the projects are completed (by definition their duration is flexible) and staff redeployed to expanding production. There may be a significant time lag.

Re point 2, retaining skilled staff can still make sense in cashflow terms, even over many months. The cash cost of recruitment and induction training for a skilled role (plus the opportunity cost) is considerable, and that's without factoring in the value of tacit knowledge and established relationships.

I'm not sure that point 3 fully allows for the shift towards part-time working, i.e. the growth in the rate of underemployment. Anecdotally, people working short hours tend to exhibit higher per-hour productivity in skilled roles (particulary "knowledge workers"), but the reverse seems to be true in unskilled roles.

Finally, just as new firms disproportionately drive productivity, so do new hires. When churn is low, new ideas do not spread from business to business as quickly. It's also worth bearing in mind the degree to which new hires in areas like IT will drive the adoption of new systems (and thus capital investment), over and above the natural replacement rate that management would allow.

[chris]

@Shinsei1967 - that might have been part of the story in 08-09, but it's not clear it is now. For one thing, in the last 2 years, business services & finance have grown more than the rest of the economy. And for another, productivity has fallen outside in other sectors. For example, output of the distribution, hotels and restaurants sector has been flat, but jobs have grown 3.5%
@ Luis - that could be happening in theory, and no doubt is for some businesses. But where's the evidence that it's widespread enough to impact these data.

[Luis Enrique]

oh Lordy, no evidence. just a hypothesis, and a pretty dubious one at that.

We're talking about a decline in the level of labour productivity here, aren't we, not just a decline in its rate of growth. I find it hard to imagine why the level might have genuinely fallen, as opposed to it being some oddity/artefact - can we really have seen a reduction in the capital stock of the size required for that to be the explanation? Has there been an increase in the overhead of unproductive regulatory compliance?

[Metatone]

@Luis

Against your hobby horse, as Chris says, its hard to find evidence.

On the plus side however, I'm absolutely seeing this pattern in a number of service businesses I have connections with. Although in part it would be more accurate to say that businesses are keeping people on to work on developing new lines of business, rather than hiring. It's definitely the case however that to develop a new service offering firms are finding that (outside of websites) you need to put more and more intangible work in before you get the thing up and running and making money.

[Tina]

oh Lordy, no evidence. just a hypothesis, and a pretty dubious one at that.

[Stian Westlake]

@Luis

Nesta's research suggests that intangible investment had also slowed 2000-08. Not as fast as tangible investment, but after a period of growth from 1990-2000, intangible investment fell slightly from 2000-2008. See the first chart on p2 here. http://www.nesta.org.uk/library/documents/Plan_I_Executive_Summary_2.pdf

So Chris probably *is* right about an investment strike pre-2008.

S

[Metatone]

It's worth noting that technological explanations (e.g. Tyler Cowen, Chris) should be treated with care as there seem to be other advanced economies in the world showing different productivity patterns.

[Kalvis]

I suggest these productivity figures could be explained by changing demand patterns. During recession consumers tend to choose cheaper alternatives which will usually have lower margins and often higher labour input. When consumers switch to cheaper alternatives we get the same headline prices (no impact on inflation), but lower revenues (shrinking GDP)and the same or even higher labour hours (falling productivity).

[Looks like Nominal wage rigidity ain't doing its usual "magic"]

Declining real wages, declining real wages and for a change declining real wages. Why should labour hoarding in the aggregate hurt cash flow of businesses if real wages are falling?

And until we see a genuine breakdown sector by sector of the productivity growth I would strongly recommend nobody going a structural explanation for it especially since it usually seems to be something about how financial services are all guff and we've been overestimating UK productivity (but then why is London doing okay still and why isn't the equally financialised/"de-industrialised" US seeing similar symptoms?

[Mymninamn]

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[Nina]

I suspect that this long labour haording might have some political undertone.
I might be wrong but this is my gut feeling!