Production, Austrian style
Productivity growth has dropped to low or negative levels in countries with unconventional monetary policies – the United States, Europe, Britain and Japan – while remaining normal in emerging markets. There are many factors at play. But the evidence recalls warnings from the so-called Austrian school of economics about the pernicious effects of easy money. One thing is for sure: reversing course won’t be easy.
Opponents of the dovish policies the Federal Reserve and other central banks have pursued since 2008 have struggled to identify where their approach was likely to lead to problems. Asset prices rose, but as former Fed Chairman Alan Greenspan has observed, bubbles are difficult to identify while they are inflating. From the conventional view of monetary theory pioneered by Milton Friedman, easy money ought to have brought about inflation. That has not been the case. Growth in consumer prices, which had started to rise by 2011, has declined to ultra-low levels since.
Productivity growth, though, has stumbled in all countries pursuing prolonged zero-interest-rate policies. In the United States, workers became 2.9 percent more productive per annum from 1948 to 1973. That declined to 1.9 percent in the years to 2010. Over the past half-decade it has plunged much further to a mere 0.7 percent a year, and zero over the last four quarters.
Across the ocean in Britain, productivity growth averaged 2.2 percent annually from 1959 to the fourth quarter of 2007. It has since collapsed to a mere 0.1 percent annually. The pattern is different from the one in the United States, with a mild recovery in the last couple of years rather than a further decline.
In the euro zone, productivity growth has fallen from 1.3 percent annually between 1995 and 2007 to 0.8 percent a year between 2007 and 2015. This is a less marked decline, partly as a result of new members from Eastern Europe catching up with more developed economies, but still a substantial change.
In Japan, labor productivity held up after the 1990 crash, contrary to concerns about “malaise,” with manufacturing productivity from 1990 to 2008 rising at a brisk 2.6 percent annual rate, somewhat higher than that of the United States over the same period. Since then, however, as stimulative monetary policies have been enthusiastically pursued, manufacturing productivity has declined at a 0.5 percent annual rate.
This slowdown in worker output has not happened to the same extent in emerging markets, where interest rates have generally remained higher. According to the Conference Board’s Total Economy Database, productivity growth in major emerging economies (Brazil, Russia, India, China, South Africa, Mexico, Indonesia and Turkey), which averaged 4.9 percent annually from 1999 to 2006, has slowed only slightly to 4.2 percent annually through 2015.
There are possible non-monetary explanations for what has happened in developed economies. Robert Gordon, a Northwestern University economist, argues that technological advances are becoming more trivial, reducing the long-term scope for greater labor productivity. Enhanced regulation, which arguably contributed to the U.S. slowdown after 1973, may play a role.
So, too, do aging populations. This hits overall output as the labor force declines but has less of an impact on productivity. The rise of inequality, which is partially a result of ultra-low interest rates, is a factor. It also may be that productivity measurements in rich countries fail to adequately reflect the new ways that workers improve their skills.
There are, however, two possible mechanisms by which ultra-low interest rates, negative in real terms, might cause unexpectedly poor productivity growth. One is through savings, an essential ingredient in the formation of new businesses, which have been somewhat depressed by low real interest rates. The rate of new business formation in the United States declined from 12 percent of all establishments to 10.2 percent from 2007 to 2013, although this continues a long-standing decline from a rate of 17.1 percent in 1977.
The other possibility derives from the work of Austrian economist Ludwig von Mises. The productivity of investment is optimized when interest rates are at their “natural” rate, taking account of the development level of the economy and the state of the business cycle. When interest rates are forced down artificially, so-called malinvestment occurs, such as in the dot-com and housing bubbles, both reducing productivity in the short term and requiring liquidation in the next downturn. The prolongation of low interest rates may, for instance, be driving excessive hotel construction or fueling record levels of stock buybacks by companies.
Restoring real interest rates closer to their natural level, which may currently be below its historic average of over 2 percent but not negative, might rectify this. But it also runs the risk of sparking recession, as poorly allocated investments are liquidated, reducing output and leading to job losses.
If the Austrian economists were correct, however, it also might restore productivity growth close to its historic trend, allowing the world’s richer economies to continue their long-term advance. In such a scenario, they’ll only get to do so after an uncomfortable dip.