"A strong, compelling explanation"

The rake-off charged by banks from sellers and buyers alike (not to mention late fees that yield the card companies even more than their interest charges these days) has been a major factor eating into retail profits and personal incomes.

- Michael Hudson

In The Puzzle of the US Productivity Slowdown, Timothy Taylor takes a look at the CBO's recent The Budget and Economic Outlook: 2019 to 2029. Taylor writes:

Why is US productivity growth slowing down? CBO is forthright in admitting: "[E]xtensive research has failed to uncover a strong, compelling explanation either for the slowdown or for its persistence ..." The report runs through a number of potential explanations, before knocking each one on the head.

Summarizing the CBO report, Taylor asks a series of questions, and answers each with an excerpt from the report. Here is a very brief version of Taylor's Q&A:

• Is the productivity slowdown a matter of measurement issues?
  

  "... probably account[s] for at most a small portion of the slowdown."

• Is the productivity slowdown a result of slower growth feeding back to reduced productivity growth?
  

  "...slower economic growth did not feed back strongly into TFP ..."

• Is it a result of less human capital for US workers, either as a result of less experience on the job or reduced growth in education?
  

  "... growth of the estimated quality of the aggregate labor force since 2005 has been only moderately slower than growth over the preceding 25 years, and that slowdown has played at most a minor role in the overall slowdown in TFP growth."

• Is the problem one of overregulation?
  

  "... Such problems have been developing slowly over time ... and are difficult to associate with an abrupt slowdown in TFP growth around 2005."

• Is the scientific potential for long-term innovation declining?
  

  "... Again, no evidence exists of an abrupt change around 2005 connected to such developments."

The best argument I can make from the CBO's analysis is that there was a Great Coincidence during which several factors must have all gone south at the same time, around 2005. But this seems highly unlikely, unless there was some other factor, one that we overlook, which caused everything to go bad all at once.

One factor that affects the economy as a whole is the rate of interest. Monetary policy raises the rate of interest to slow economic growth, as you know, and lowers the rate of interest to increase economic growth.

Another factor that affects everything is something I call "the factor cost of money". This cost is equal to the rate of interest multiplied by the number of dollars on which interest must be paid. The factor cost of money is an actual cost, like the factor cost of labor or the factor cost of capital. But there are differences.

A rise in the cost of labor is an increase in wages which is good for workers and, rule of thumb, good for consumers.

A rise in profits is good for producers.

A rise in the factor cost of money is good for finance, the non-productive sector.

A rise in any of these factor costs will add to the cost of the things we buy, which affects everyone. There are also benefits, of course. But which factor it is that receives the benefit depends upon which factor receives the increase. A rise in the factor cost of money, for example, will drain money from consumers and producers while increasing the return to finance.

A rise in the return to finance, ceteris paribus, by draining money from consumers, will reduce aggregate demand. By raising costs for producers it will reduce economic vigor. The fall in aggregate demand and the decline of vigor will combine to reduce producers' profits. The reduction of producer profits coupled with the rise in the return to finance makes financial wealth more appealing than productive wealth. This induces additional money to move out of the productive sector and into finance, and leaves the productive sector even more reliant on borrowed money.

As financial costs rise in the productive sector, producers cut corners. They become less able and less willing to meet demands for wage increases. Employee compensation lags.

The economy develops a vicious cycle of rising prices and declining incomes -- something that doesn't even make sense until you remember that income is being drained away from producers and consumers by finance.

A change in business financial costs will certainly affect business costs. Likewise, a change in household financial costs will affect consumer spending, and the resulting change in demand will affect business activity, output produced, labor hours consumed, and productivity.

Rising cost does damage to productivity growth. But cost seems to be missing from the CBO's list of possible causes for the productivity slowdown.