Productivity decline as a source of cost-push pressure

On or about 13 November I went looking for the quoted search term "cost-push" at some 30 blogs I've been to many times over the years. Made some notes and did nothing with them, just gathered em up.

On or about 20 December I noticed, new from Dietrich Vollrath, When did productivity growth slow down? Vollrath is usually a good read. 

Some questionable stuff in his post, such as 

The received wisdom is that we are living through a period of slow TFP growth, and that this slowdown in TFP growth kicked in around the early 2000s. But I’m not sure that’s the whole story.

Not sure??

And there's some unquestionable stuff in there, like

When you zoom out further you’ll find that if there was a slowdown in productivity growth it started in the late 1960s or early 1970s and has continued through today.

and

If we’re having a discussion about what went “wrong”, then we need to look way earlier than the early 2000s to figure it out.

I always want to look earlier, so definitely yes to that. And I've known since forever that the productivity slowdown started mid-70s but more recently I question that date, and Vollrath's "late 1960s" is the kind of earlier that I like to look at.

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On or about today, I was looking thru my "cost-push" notes of the 13th and found this excerpt from Inadequate Productivity + Rising Rates of Return on Capital = Reduced Labor Share of Income:

A change occurred in the late 1960s / early 1970s, however, as labor productivity slowed. Under the then-current regime, labor income continued to grow in line with the economy, maintaining its share of total income. Because productivity was no longer rising as much as previously, though, the return on capital consistent with a constant share of total income could not deliver an adequate rate of return – a profit squeeze ensued. This drove firms to increase prices, leading to larger wage demands and cost-push inflation.

from Postings from along the Trail... by hmg, Jr.

In my notes there was only the excerpt, no evaluation. Maybe I gave it a little extra attention today because of the "late 1960s" thing coming on the heels of Vollrath's "late 1960s" thing. Whatever the reason, this hit me hard today:

• labor productivity slowed
• labor income continued to grow
• a profit squeeze ensued
• and cost-push inflation.

Usually, when you look up cost-push inflation, you find something like

rising costs push up prices.

Usually the rising costs are wages and oil. If you are as unimaginative as I am, and you read article after article after article looking for something more, you get nothing but tired of reading the same story over and over again.

That's why my "financial cost-push" theory strikes me as such a big deal, and why hmg Jr's

productivity decline as the source of cost-push pressure

concept is such a thrilling thought. With cost-push, you only need something to get it started. After that, the solution to the problem of rising costs creates more rising costs, and you've got a spiral. With hmg Jr's explanation and my own, I now have two explanations of how cost-push got started.

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hmg, Jr puts the start of the productivity slowdown at 1965, right where Allan Meltzer puts the start of the Great Inflation.

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So we start with high productivity in the post-WWII period, and a rule that says wages should increase with productivity. It's a nice rule because it means we can afford to buy the output we produce. Equilibrium is satisfied, and economists are happy.

But then productivity drops off, and before you know it wages have gone up more than the rule allows. A high wage share means a low profit share, and that is a problem. The problem is solved by suppressing wages and restoring profit share.

Great.

I'm not sure how this all works, with productivity and growth complicating things. Let me imagine an economy where productivity -- output per hour -- grows 3% per year, and everything else is ceteris paribus fixed.

So output grows at 3%, labor gets two-thirds, capital gets one-third, and I don't know why it works but I think that is the story. And everything is fine for a while. And then productivity falls by half.

So now output grows at 1.5%. If labor still gets two-thirds and capital still gets one-third, everybody gets half what they got before. (So I could see right away that cost pressure rises, because everyone wants as big a piece of the pie as they got before. That part I got.)

For some reason it is not okay if capital has to take a cut, but it is okay if labor has to take a cut. I don't know whether the reason is economic or political, but capital still has to get 1%. Before, when they got 1%, there was 2% left over for labor. Now there is only half a percent left over for labor.

And that's pretty much the story hmg, Jr. tells.

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There are still a lot of loose ends between my ears, but I think I have the general picture. It's just the increase that gets reduced, not the whole amount, assuming I understand the process.

In the time of 3% productivity, if we got 100 last year then this year we get 103%. In the time of 1.5% productivity, if we got 100 last year then this year we get 101.5%. The 100 doesn't go down, just the addition gets smaller. And labor's share of the addition gets smaller.

In the Economic Forecast post, however, hmg, Jr. foresees further decline due to the retirement of the baby boomers and the consequent fall in the size of the labor force:

Whereas from the 1970s until the advent of the baby boom's retirement, reduced productivity growth allowed for either rising real wages and constant real profits (a falling return to investment), or rising real profits (a constant return to investment) and constant real wages, it is unlikely that this will continue. For real profits to continue to increase, delivering a constant return to investment, real wages must now fall. The “game” has changed from one approximated by zero sums, to a closer approximation by negative sums.

If productivity goes below 1%, then for capital to get its 1%, labor has to give up its productivity gain entirely, and more besides. (Except now it's not productivity falling. It's labor force size.)

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I don't see hmg, Jr. addressing the question of why productivity fell. Maybe I missed it. I've heard it said, though, that productivity fell because baby boomers brought to the labor force their inexperience in quantity sufficient to cause that decline in productivity.

Nice, right? I'm a baby boomer. When I started working, I made productivity fall. And then by retiring, I made things worse again. I just can't win.

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Meanwhile, hmg Jr. lays out a clear picture:

Measuring a real standard of living by real output per capita as “Y/N”, labor productivity as “Y/L”, and labor per capita as “L/N” – where “Y” is real aggregate output, “L” is aggregate hours worked, and “N” is the level of population – the following equation relates them: Y/N = Y/L * L/N.

 The equation Y/N = Y/L * L/N is a version of growth accounting. Dan Sichel:

The speed at which the economy can grow over a longer horizon is determined by changes in two main factors: the total amount people are working — which involves both the number of workers in the labor force and the hours they work — and the efficiency with which they produce goods and services.

 Let me repeat what I said the other day:

I have no trouble accepting the idea that an increase in the labor force or an increase in productivity can boost economic output. But I cannot accept the ridiculous notion that nothing else plays a role in boosting output.

I think we have to go back to why productivity fell. I think it has to do with cost.