The Economics of Persistent Slumps

This week I went with a friend to the Philips lecture  at The London School of Economics and Political Science (LSE) with Professor Robert Hall of Stanford University, originator & author of ‘The Flat Tax’   & one of the founders of Macroeconomics (author of one of the first books on the subject and now the standard University textbook on Macroeconomics )

The gist of the lecture was how productivity has declined in the USA. Areas of concern included the rapid fall in the Labour participation rate, which has now started to affect women (who previously were increasing in the labor force quite rapidly) too.

The biggest surprise here is that almost all of the decline in the Labour force is in the top levels of income and education.

Professor Hall speculated about a number of reasons for this. One rather novel one, was that fifty or sixty years ago, there was very little in the way of entertainment. If you chose not to work, even with a high income, life could be quite dull. These days there are a variety of interesting pursuits, that can occupy people all their life, without them having to work.

It would be interesting to pull a chart of video game use in the last thirty years and match it with the fall in work participation rates for high-income youth.

Another interesting chart to look at would be the increase in benefits and the fall in the work participation rates. My suspicion is that a lot of people claiming benefits are not truly unable to work.

I myself had a medical condition, that was classed as a disability for seven years. I could have claimed disability benefits for it. Fortunately, I worked through it and now I'm healthy again.

The toll on one's self-esteem of claiming money for doing nothing is rarely considered when debating the government benefits system.

Almost all the Labour participation shrinkage in the US Economy is from the richest and most highly educated sectors

Professor Hall calculated that US GDP would be approximately 15 percentage points higher if this and a few more minor issues were addressed. He was only covering the US in his lecture. However, I'd imagine these issues with productivity will only be worse for some of the other developed countries if you look at this chart below. 

Current GDP per hour worked, G7 countries 2013 and 2014

Where the missing 15 points of GDP went

Hall put a number on all this. By his calculation, US real GDP in 2015 was about 15 percentage points below where it should have been. The striking part is how he broke it down. Only a sliver is the kind of unemployment that recessions cause and recoveries cure. The rest is structural: slower productivity growth, 6.6 points; depleted capital stock (less business investment and R&D), 5.1; a shrunken labour force, 3.3; excess unemployment, 0.5. Total: 15.4.

Two things stand out. First, the labour-force shrinkage I have been describing is worth 3.3 points of GDP on its own, more than six times the damage done by unemployment. Second, the two biggest items, productivity and capital, are the ones nobody can fix with a stimulus cheque. Output per unit of input has been drifting down for years, and business investment, including spending on intellectual property, has drifted down with it. An economy that invests less and gets less from what it invests will not grow, however low interest rates go.

What would bring people back to work

If 3.3 points of GDP are sitting on the sofa, the policy question is how to get them off it. The usual answers, childcare support, retraining for mid-career workers, apprenticeships for the young, all help at the margin. But they are aimed at people who want to work and cannot. Hall’s data say the bigger loss is among people who could work and choose not to. That calls for different tools:

• Phased retirement rather than a cliff edge. Let older, experienced workers cut their hours gradually, and reward those who work past the traditional retirement age with higher future pension entitlements instead of penalising them.
• Make flexible and part-time work the norm for skilled roles, so that a parent, a carer or a 62-year-old can stay in the labour force at half-time rather than leave it altogether.
• Go after the high-income opt-outs directly. Nobody runs outreach programmes for well-off, well-educated people who have stopped working, because nobody thinks of them as a problem. On Hall’s numbers they are the largest part of it.
• Fix the incentives in the benefits system, so that working through a difficult period is always financially and psychologically better than not working. That is the part of the argument I feel most strongly about, for the reasons above.

None of this is cheap or quick. But the alternative, as Hall showed, is a developed world that is quietly 15 per cent poorer than it ought to be. And what is bad for the USA, is even worse for Europe, and the UK, which has seen productivity flat-line now since 2008. 

We rounded off the night with dinner at The Delaunay.