Productivity puzzle and make-work


The great American make-work programme

Osborne’s unorthodox solution to the UK productivity puzzle

Banks, businesses or the bust? Deeper into the UK productivity puzzle


UK Productivity Puzzleuk-disposable-income

The UK has outperformed at creating jobs since the crisis, yet has done poorly at boosting living standards.

<- the problem is a combination of collapsing productivity and insufficient capital investment.

uk-gdp-decompositionquality-adjusted labour input” — hours worked adjusted by education and experience

More talented people are working more than ever — UK labour input has grown at an annual average rate of 2.5 per cent since the middle of 2011— yet the reported value of what all those people are doing has collapsed.

Possible theories:

1.After financial crisis the financial system cut lending, especially to upstart businesses  [1]


But the growth rate of underlying productivity plus the capital stock had begun slowing by mid-2004.


And lending wasn’t expensive

Composition of corporate is also not a good explain, as all businesses experienced a big drop in underlying productivity since 2008. [2]


2. “general demand weakness coupled with flexible wages”

Businesses take advantage of low nominal wage growth and low interest rate to survive in a low-demand environment [3]

A solution:

Firing a bunch of low-wage workers raises the average pay of whoever is left and therefore raises measured productivity. [4]
In America, the savage cuts in employment during the crisis caused a temporary spike in measured productivity.


But American also suffers after 2010

fredgraphfredgraph-1chartMoreover, a more secular problem is
A staggering 96 per cent of America’s net job growth since 1990 has come from sectors known to have low productivity
(construction, retail, bars, restaurants, and other low-paying services were responsible for 46 percentage points of total growth)

and sectors where low productivity is merely suspected in the absence of competition and proper measurement techniques
(healthcare, education, government, and finance explain the remaining 50 percentage points)

Even given the fact that gap between low and high productivity industry is expanding


It’s tempting to conclude

  1. many of these additional workers are doing little to boost real living standards
  2. their continued employment is effectively the product of subsidies extracted to provide make-work, rather than the result of competitive market conditions
  3. part of the slowdown in measured productivity to these shifts in the composition of the workforce

If we check changes in employment since 2000


94 per cent of the net jobs created were in education, healthcare, social assistance, bars, restaurants, and retail, even though those sectors only employed 36 per cent of America’s workforce at the start of the millennium


Average hourly pay in these sectors, weighted by their relative sizes, has consistently been about 30 per cent lower than in the rest of the economy. (even lower considering the less work time [5] )

One could argue these are things that can’t be done either by machines or, to a lesser extent, by far cheaper foreign labour.
And aging society implies somewhat greater spending on healthcare and more employment in the sector.

A simple conclusion:

Employment booms in 21 century are no longer caused by the rapid growth of the most-productive enterprises like it used to be.



Is it something familiar? Yes, We’ve seen some picture about Japan that shows a high work participation but growth dominated by part-time labors. And don’t forget, Japan has the biggest aging problem in world and its labor productivity has been essentially flat for 20 years!



Economists at the Bank of England and the Institute of Fiscal Studies recently suggested that an impaired financial system since 2008 has prevented resources from being moved to their best uses, which in turn has dragged down output per hour by a significant amount.

Manufacturing firms in the US, Japan, and Western Europe are far more productive than firms in places like India and China because the gap between the best and worst manufacturing firms in poorer countries is much wider than in the rich world. That, in turn, is because the best firms in China and India often face constraints on their ability to expand. In theory, narrowing the gap could boost aggregate manufacturing productivity by around 40 to 50 per cent.


A fascinating new paper from the National Institute of Economic and Social Research, which shows the UK productivity problems aren’t concentrated in any particular sector.

And businesses that died off in 2008 were of lower average quality than those that died off in previous years, which should also raise the overall productivity of the remaining companies.

According to the NIESR researchers, productivity growth within surviving manufacturing firms accelerated during the early 1990s.


The recent recession was different to the previous recession because productivity growth collapsed within firms. This is unlikely to be directly related to credit restrictions, which would not have prevented businesses from laying off workers. It is more likely to be associated with the lack of cost pressures, including low nominal wage growth, that allowed businesses to survive in a low-demand environment. High nominal interest rates, an overvalued exchange rate and continued wage growth in the earlier recession are likely to have incentivised surviving businesses to continue to boost productivity growth to a far greater extent than was the case in the most recent recession.

However, there is no intuitive connection between the rate of inflation (a nominal variable) and the propensity for businesses to boost productivity (a real variable) .
In fact, the 1990s consensus was price stability led to faster productivity growth because businesses could only boost profits by cutting costs with the help of technological and process improvements.

(QE might create a invisible inflation that matters for business decisions.)


If the labour on offer isn’t worth this minimum price, employers will prefer to substitute people with machines, or invest in other improvements to offset the declines in hours worked, or perhaps even endure lower sales if it means better earnings.

Hence a lot of economists are wary of raising the minimum wage too much because it would reduce employment among those who already have the lowest living standards and most volatile incomes.



And since typical jobs in bars, restaurants, and retail involve far fewer hours than normal, weekly pay packets for workers in these growing industries were more than40 per cent lower than workers in the rest of the economy. Average weekly earnings are now 3 per cent lower than they would have been if the distribution of employment had stayed the same as in January, 2000:




Balanced growth


Is there evidence of balanced growth?

Balanced growth in theory


The main organizing principle in growth economics over the last sixty years :
“balanced growth path”

“Kaldor Facts” [1]

  1. The growth rate of output per worker is constant over time
  2. The rate of return on capital is constant over time
  3. The share of output paid to capital is constant over time

Empirical Check


cbo_fit_postallFor the US, it seems there is very powerful evidence for constant growth of output per worker.


But not every country has such a consistent trend line.

  • a BGP is really a statement about what happens in the long run. Like Germany or Japan, you could be off of the BGP, but will eventually settle into a situation of constant growth rates.


France shows a further departure, not only a shift in the level of the BGP, like Japan, but also a change in the slope,meaning the growth rate was permanently higher.

paper recently checks 26 countries whether their path of GDP per capita follows a strict BGP:

  1. a strict BGP is only for the US and Canada
  2. no for the rest of the OECD and the other Asian countries


If return to capital is measured by take total payments to capital ratio (dividends, rents, or interest)

fig_mpk_1960There was a distinct decline in the return to capital over the post-war period

If measured by bond yields


40-year deviation from 5% between about 1970 and 2010 seems like an abuse of the word “tendency”

Or stock earnings yield.


It looks like a tendency to be around 6-8% over the long run, with a distinct dip in the recent few years.


But for UK and France, return to capital shows some stability over long periods of time.




This looks as if the capital share is rising over the last 40 years for all these countries


The inverse of this is the decline in labor shares. A paper  has investigated both if and why this is occurring.

Theoretical Issues

Uzawa’s theorem: 

If an economy has a BGP, then what Uzawa indicates is that it either has a very specific production function (Cobb-Douglas) or a very specific rate of progress in capital-augmenting technology (zero)

It feels implausible that the real world actually would have the exact right conditions

Relaxing Uzawa:

GHOS suggest is that human capital growth may be sufficient to break the strict nature of Uzawa’s conditions.
a model of economic growth that doesn’t require Cobb-Douglas production, has a positive growth rate of capital-augmenting technological change, and yet still has a BGP.

A different approach establishes conditions by which the aggregate production function may be Cobb-Douglas, even though the underlying technical production functions of firms are not.

Structural Change

There has been significant shifts of labor between sectors (generally, ag to manufacturing to services) over time in most economies.

Acemoglu and Guerrieri, Kongsamut, Rebelo, and Xie, Ngai and Pissarides, among others, are new versions of Uzawa that also allow them to account for structural change. [2]


For those countries appeared to go from one BGP to another, the existing models are good at capturing the dynamics within each BGP,
but they have no way of explaining why it was that South Korea took off for a different BGP in about 1960, or why France’s growth rate shot up after World War II. These shifts are completely exogenous in these models.





These three conditions are part of the the “Kaldor Facts” established in by Nicolas Kaldor in 1957. These facts were supported by relatively sparse information gleaned from the period running from the late 19th century up to the 1920’s, and for most of them Kaldor ignored major changes that occurred in the Great Depression.


They establish conditions for preferences or production functions that allow for economic activity to wax and wane in different sectors, but in aggregate continues to be consistent with Kaldor’s facts.