A couple of years ago, McKinsey, the global management consulting firm, launched a new website called What Matters. It asks a big question and invites a wide array of people to write essays giving their points of view on the topic. In 2009, for example, What Matters addressed Innovation, and asked, Where will the world’s primary centers of innovation be? I was invited to participate and contributed an essay, “What’s Next in the Knowledge Economy?”
Earlier this year I was once more invited to contribute an essay on the topic of Growth and Productivity, focused on the question: Has the US passed peak productivity growth? I wrote “The next golden age of innovation”, which was posted last month.
A number of eminent economists also contributed essays on Growth and Productivity. I was truly humbled to have my essay posted alongside theirs.
Two of the essays in the section revolve around recent work by Michael Spence to try to understand the reasons for the current jobless recovery in the US economy, a fairly unique situation where business conditions have significantly improved while unemployment remains high. Professor Spence is the recipient of the 2001 Nobel Prize in economics. He is currently in the faculty at NYU’s Stern School of Business, as well as professor and dean emeritus of the Stanford Graduate School of Business.
The tradable sector is the part of the economy most exposed to global competition from foreign companies and suppliers. It includes most manufacturing, agricultural, mineral and energy products. More recently, an increasing number of business and financial services have also become tradable. The nontradable sector is the part of the economy that must be produced and consumed locally, including government, health care, construction, retail stores, restaurants, hotels and transportation.
Spence and Hlatshwayo examined the evolving structure of the American economy from 1990 to 2008 by looking at its tradable and nontradable components using data from the US Bureau of Labor Statistics and the Bureau of Economic Analysis. As reported in this Washington Post column by Steven Pearlstein:
“When they looked at what happened between 1990 and 2008 - a period of rapid globalization - two things stood out.
“One was that all the job growth came pretty much in the non-tradable activities, in particular government and health care, while across wide swaths of the tradable manufacturing sector, jobs declined significantly.
“The other thing they noticed was that in terms of economic value-added - the ‘output’ that is measured by GDP and generally correlates with income - the tradable sector experienced a slight edge.
“Put the two together - the very unequal employment growth and nearly-equal output growth - and what you get is an economic tale of two cities, one that is growing in terms of jobs but not income, another that is growing income but not jobs. In short, a recipe for increasing inequality and social and political polarization.”
These conclusions were the jumping off point for the What Matters essay, Not all productivity gains are the same. Here's why, by economists Michael Mandel and Susan Houseman. Their short, well written paper analyzed the results of the Spence-Hlatshwayo study in an attempt to understand this tale of two cities and the apparent paradox inherent in our jobless recovery.
“Most economists believe that productivity gains are the surest way to raise the standard of living of a country. Yet despite apparent strong productivity growth in recent years, Americans have been hit by a deadly combination of stagnant real wages and a lack of good jobs for mid-income workers. . .
“Under ordinary circumstances, economic theory would tell us that an industry with rising productivity would pay higher wages and/or boost employment. However, real wages for many production and nonsupervisory workers stagnated in most tradable industries during this period [1990 - 2008], even as jobs disappeared. Notably, the durable goods manufacturing sector showed only a 0.2 percent cumulative increase in real wages for production and supervisory workers from 1990 to 2008, despite more than doubling in productivity over the same stretch, according to the Bureau of Labor Statistics.”
The problem, they point out, is that US statistics do not differentiate between three very different scenarios for achieving high productivity or value-add per job, especially in the tradable sector of the economy:
- Improvements in domestic production processes
- Gains in global supply chain efficiency
- Productivity gains at foreign suppliers
“Each of these components of ‘productivity growth’ has different implications for real wages and for the creation of new jobs,” they observe. “Understanding the distinctions among them can improve understanding of our current situation and open up new avenues for policy.”
The first component – improvements in domestic production processes – is the classic, pre-globalization economic model in which improvements in productivity translate into increases in the real wages of workers and the overall standard of living of the country.
The next two – the post-globalization components – are very different. “These days, corporate executives are continually adjusting their global sourcing, with the goals of reducing costs and maximizing profits. In particular, there has been a large-scale shift from suppliers in the United States and other high-cost countries to suppliers in low-cost countries. . .”
“All else being equal, economic theory suggests in this scenario, real wages and/or employment should rise for managers who are capable of identifying additional global opportunities to cut costs.” Real wages and employment opportunities will also likely rise for the foreign workers who are now involved in producing parts and performing services as part of the supply chain of global enterprises.
But the rise of measured productivity in these global enterprises, due to improvements in their supply chain efficiency and the productivity gains of their foreign suppliers, will probably be correlated with a decline in the employment of US workers and/or a decrease in their real wages. This is the essence of the major structural changes in our global economy that productivity and labor statistics have not yet caught up with.
What are the implications of these global structural changes on the public policies of the US and countries around the world? Michael Spence addresses this question in Fixing the US Jobs Problem, the essay he contributed to the What Matters Growth and Productivity topic, as well as in The Evolving Structure of the American Economy and the Employment Challenge.
I will discuss his recommendations for fixing the US jobs problem in next week’s blog.