The illusion of lagging economic productivity

I miss 2011. Looking back, that was the heyday of economic blogging. The financial crisis had abated, but the recovery from the recession was disappointing, and everyone was talking about how to jump- start growth. Macroeconomics was important again. Now, with the United States economy having returned to some semblance of normal, and with political threats looming, the finer points of macroeconomic modelling don't seem like life-and-death issues.

With no financial crisis and recession to argue about, economists and bloggers have turned their attention to long-term issues. One of these is technological progress. Economists identify technology with productivity and they often equate the two exactly. That gives economists the feeling that they have something to say about tech.

Much of the debate focuses on whether technological progress is slowing down. Professor Robert Gordon, economist at Northwestern and author of The Rise And Fall Of American Growth, is the champion of the stagnationists. Many believe his argument. Others accept the idea that growth has fallen, but point out that no one can know the future of technology. Still others argue that the fall in productivity has been understated, because technology helps us enjoy our leisure time more, or because it's inherently hard to measure the value of free software products.

Enter Dr Dietrich Vollrath. A professor of economics at the University of Houston, Dr Vollrath has quietly created one of the best economics blogs on the Internet. Focusing on growth economics, he uses his uncommon explanatory skills, mixed with just the right amount of maths, to draw startlingly simple insights out of complex topics.

Since growth ultimately depends on productivity, this means he spends a lot of his time talking about the very issue at the centre of the stagnation debate. He's no polemicist - his analyses sometimes lend support to one side of the argument, sometimes to another. In one particularly excellent post, he shows a very natural reason why we should expect productivity growth to fall during the long term - basically, industries where tech improves quickly tend to become a smaller and smaller part of the economy as their products become cheaper and cheaper, leaving slow-improving industries to consume most of our effort. This idea has been around for a long time and is known as Baumol's cost disease, but Dr Vollrath does the best job of explaining it that I've seen.

In a pair of recent posts, the first in September 2015 and the other earlier this month, he gives a reason not to worry quite so much about the productivity slowdown. Essentially, some part of it might be a statistical illusion.

Economists usually equate technology with total factor productivity, which is equal to gross domestic product divided by some function that measures how much labour and capital the economy is using. Dr John Fernald of the Federal Reserve Bank of San Francisco is generally considered the best at doing this. Here's his time series of productivity changes since 1990: It's plain there's been a slowdown in this growth rate since the early 2000s. That's part of why people are now taking the stagnationist argument so seriously.

But as Dr Vollrath shows - in the first post with algebra, in the second using plain English - there's at least one kind of measurement error that could be dragging this number down. If companies are collecting more economic rent - meaning, profits from not producing anything - but statisticians don't pick up on this, it gives the appearance that businesses are over-consuming capital. That in turn makes it look as if they're less efficient than they really are.

In other words, if companies are sucking up more rents, it makes measured productivity lag behind true technological progress, and gives the appearance of a more severe stagnation than actually exists.

So what lets companies suck more rent out of the economy? Lack of competition. If the government grants too much intellectual property protection, for example, that can help incumbent companies keep out newcomers and preserve fat profit margins at the economy's expense. If new technology allows companies to create natural monopolies, that can have a similar effect. Lax antitrust regulation, changes in the financial system, overregulation and simple cronyism could all have similar effects.

And the fact is, industrial concentration is rising. Market power is increasing. This is dangerous for the economy, as any Econ 101 teacher will tell you - it might be creating some true productivity stagnation. But as Dr Vollrath shows, it also might be giving the appearance that the stagnation in technology is worse than it actually is.

So the next time someone brings up Prof Gordon's book at a cocktail party, mention this possibility of mismeasurement. Just one more reason why econ blogs are still useful to have around.


A version of this article appeared in the print edition of The Straits Times on August 25, 2016, with the headline 'The illusion of lagging economic productivity'. Subscribe