-- Posted Friday, 18 November 2011 | | Disqus
By David Collett
The Best Governments Money Can Buy
Demand, productivity and employment and its effect on economic growth
The economic physicians of the world economy are desperate. Despite all their extensive efforts, using every medicine at their disposal, the frail patient has suffered another setback in 2011. What concerns most is the realisation that the virus that infects the world economy has become resistant to all the conventional treatments. Any additional doses of the medicine seem to weaken the patient even further. The world economy has become so fragile that any major shock to its system may well cause irreparable harm.
Economists and market commentators have become desperate in their efforts to determine the underlying causes of a worsening economy. Some grasps at straws in an effort to unravel the mysterious illness of the economy, but few waver to propose a prescription which they believe would heal the patient. Others simply deny that the economy is unhealthy. Unfortunately, the diagnoses and prescriptions are often viewed through political and ideological lenses. Some of the more persistent views are as follow:
1. Governments lack leadership, are ineffective and must get out of the way of the private sector
2. The corporate sector does not want to invest its trillions of dollars in cash because of uncertainties – the government must therefore actively pursue policies to create certainty
3. Capitalism has been sold out to socialism.
4. Higher growth can only be achieved by an increase in productivity
5. The corporate sector produces spectacular profits – proof that the patient is well
Many of these views have some merit but by no means do they address the underlying problems of the world economy. Neither does it prescribe any new medicine which has a realistic change of healing the patient. To face the true nature of the underlying problem is to look in the mirror – to know the spreading virus is us. By nature we refuse to accept diagnosis or prescriptions which are not in line with our ideologies, our believe systems and our status in life.
The Best Governments Money Can Buy
This issue has been raised before, but the significance of it is often lost when economists and the private sector criticize governments for our current economic predicament. The truth is that many developed countries, especially the USA, have the best government that money can buy.
If we take stock of the large amounts of money that the private sector, think tanks and other interested groups have spent on the election campaigns of state and federal government representatives and the costs of lobbying these officials to influence and dictate the direction of legislation, subsidy schemes, government contracts, regulatory oversight, economic policies etc.; it is difficult to see how they can act independently, let alone give strong leadership.
Can we expect these puppets to show leadership?
The insurance, commercial banking, accounting, and securities industries made nearly 1 billion in campaign contributions to American politicians over the last decade and paid just over $2 billion for lobbyist to act on their behalf according to the Centre for Responsible Politics. There are around 17,000 lobbyists working in Washington DC, outnumbering lawmakers in US Congress by about 30 to one. The Glass-Steagull Act, which introduced the separation between commercial and investment banking, was a likely casualty of such lobbying by the financial industry. We all know by now how the ensuing consolidation or merging of commercial banks, investment banks, securities firms and insurance firms ended in a widespread banking crisis in 2008 and how governments had to bail them out.
In a detailed study, the Research Department of the IMF, found that lobbying was associated with more risk-taking lenders during the 2000’s. Where the lenders were more likely to benefit from lax regulation, they lobbied most aggressively which allowed them to engage in riskier transactions and consequently exposed them to worse outcomes during the banking crisis. Not surprisingly, these lenders also benefitted most from subsequent government bailouts.
Extensive lobbying also applies to other corporate sectors including members from the oil and energy sector which together with some parties from the financial sectors, pay little or no taxes despite billions of dollars in profit. According to Actionaid International, the pharmaceutical industry by themselves spent over $1 billion lobbying in the US in 2004 alone.
In Europe the latest scandal is the “doozy” where members of the European Parliament showed a willingness to accept cash for request by lobbyist to make amendments to legislation. In the “doozy case”, the “lobbyist” turned out to be journalists from a newspaper investigating how much influence they could buy. Interestingly, such acceptance of cash by members of the European Parliament for amending legislation is apparently perfectly legal.
There is different ways to view the above. One view is that such lobbyists supply politicians and governments with valuable information to make informed decisions. Another view is that lobbying has become a sophisticated form of bribery whereby the lobbying party gains an unfair advantage to the detriment of its competitors and the community at large. Both views may have some truth to it. Irrespective of one’s view , it’s hard to deny that in a system where corporate businesses spend huge amounts of money (sometimes more than the tax payable by them) on lobbying, they do so to influence the political system and economic policies in order to gain a benefit from such influence. Private enterprise would not invest in such activities if it did not turn a profit, one way or the other. Due to the size of their contributions, big business obviously has a structural advantage in terms of their access to and influence on decision-makers.
Although there is competition between various corporate interests when they actively pursue public support during election campaigns to get their A-team into power, it does not make much of a difference if the B-team wins. No independent or unsponsored party has any realistic chance to get elected as the mainstream media will simply “crowd them out”. Of course, the electorate must carry an equal part of the blame as they have overwhelmingly rejected candidates who are not part of the A-team or B-team.
From a practical point of view, one has to accept that the highest bidders will be the winners and that they will continue to be the dominant influence on governments and its economic policy in the foreseeable future. Small business and members from less wealthy communities have become relatively less influential and relevant in this lobbying game. Many governments have become “corporate agents” under the continuous guidance of the corporate world and other influential groups. Few of these guiding groups, if any, harbour socialist ideals. Governments are largely controlled by capitalist who are committed to their brand of free enterprise.
It’s therefore ironic that many of the economist and market commentators, who consider themselves as free market champions or pure capitalist, now call on the government to “step aside” and heap criticism on them for lack of leadership, creeping socialism, bad economic policies and the inability to act cohesively in an effort to save the economy. How can one expect strong leadership from elected officials when they are continuously pressured and “guided” by self-interested parties that heavily contributed to their election campaigns?
Governments’ agendas have become indistinguishable from that of private enterprise. Did they not accede to virtually all demands in the bailouts that followed the 2008 credit crisis? Did they not help the big corporates to socialise their losses when they needed government assistance and allow them to privatise their profits when conditions became more favourable? Did they not exercise pressure to insure that accounting boards relax the “mark to market” accounting rules which some incorrectly advocated as a major cause of the crisis? Did they not lower taxes over the last three decades, especially for the top income earners, so that the wealth it promised to create could trickle down to all the citizens? Can anyone honestly deny that these demands came from anyone but the purist of capitalists?
The accusation that governments have become more socialistically oriented and are waging class warfare against the rich is somewhat amusing and counterproductive for those who want to further the course of capitalism. If governments would stop faking some sympathy for small businesses and the less wealthy groups, or refrain from softly slapping the reckless entrepreneur or banker on the wrist, it would render them less effective in giving big business and many other members from private enterprise what they want. If economists or market commentators really want any major change, convince big business and/or the powerful lobby groups that it’s in their or their client’s interest to do so and the job will most likely get done. Those with the biggest budgets will win more often than not. That is the capitalistic way.
There are also many supporters of free enterprise that are of the opinion that democracy should rule and regulate capitalism to ensure a measure of risk control and a level playing field for all participants. The enormous influence exercised on decision-makers by members from the corporate world and other powerful lobby groups, makes this impossible. Some of the strongest supporters of capitalism have acknowledged that they cannot be expected to discipline themselves in the pursuit of profit. We need strong independent governments to do that.
Unfortunately, that is not the way it works at present and the status quo is probably going to continue for some time to come. In the meantime, the identity of the virus that attacks the world economy will not be admitted, nor will we administer the bitter medicine required to heal the patient.
Demand, productivity and employment and its effect on economic growth
Some argue that productivity growth rates must improve before the economy will regain its previous robust growth. Innovation and increased productivity are seen as an essential prerequisite to higher growth. Many are alarmed by the relative lower productivity which has befallen the developed world in 2011.
Let us look at the problem of the United States. The US Bureau of Labor Statistics (BLS) produces quarterly figures for labour productivity growth for the manufacturing sector and nonfarm businesses. Labour productivity is calculated as the output per labour hours worked. When we look at historical productivity trends, downward movements in productivity growth seem to coincide with major slowdowns in the economy. The current low productivity (1st and 2nd quarter of 2011) figures are mainly a by-product of a slowing economy and not the cause of it or a sign that workers have become less efficient.
When the economy slows, demand drops followed by a drop in output and a reduction in labour hours and employment. A drop in production (due to a drop in demand) which is faster than a drop in hours worked and/or layoffs will always result in a lower and often negative growth in productivity. The opposite is also true; if production increases faster than employment (hours worked), productivity growth will increase. This seems obvious enough, but it’s the interpretation of the data which causes some to come to the wrong conclusion.
Let’s look at some charts which cover the period from 2004 to 2011 and analyse the relationship between demand, employment, production (supply) and productivity. In the first chart we compare real retail sales (RRSFS – Blue line) to nonfarm payrolls (PAYEMS – Red line). The shaded area indicates the time period for the recession that started in 2007.
From the above chart it’s clear that demand, represented here by retail sales (inflation adjusted) started to decline before the recession began. Employment continued to grow till January of 2008 before it started to descend into a steep decline until the end of 2009. While retail sales made an upward move in the second quarter of 2009, net layoffs continued into the 2010 calendar year. When it started to recover in the beginning of 2010, its pace of recovery did not match that of retail sales.
In the next chart we compare the output of the manufacturing sector (OUTMS) with real retail sales (RRSFS). The close correlation between the two is obvious.
It is notable that output (green line) made a small surge upwards just before the recession started and that its decline lagged retail sales (blue line) by a few months. Output then descended with retail sales but it slightly lagged retail sales in the recovery phase which started in 2009. The above chart indicates that retail sales (demand) was a leading indicator at both the start and end of the recession. For this reason it’s noteworthy that real retail sales flattened somewhat in 2011 and turned marginally negative in August of 2011. Production and manufacturing reports show a significant slowdown in nonfarm and manufacturing output growth for the 2nd quarter. If real retail sales continue to decrease in the coming months, it’s virtually a given that output will follow it to lower levels.
In the chart below we compare industrial production (INDPRO – Red line) with nonfarm payroll employees (PAYEMS – Blue line).
Most notable, industrial production’s (Red line) decline was steeper than that of nonfarm payrolls (Blue line) and it recovered upwards earlier and at a much steeper incline than nonfarm payrolls. Therefore, one would expect a decline or slowdown in the growth of productivity in the 2008 calendar year followed by a steep increase in productivity from the second half of 2009 and throughout 2010. The BLS productivity growth figures show that labour productivity did act accordingly.
The above charts followed the expected pattern. It started with a drop in demand (real retail sales), followed by a drop in production, and followed by a reduction in employment. As long as the reduction in employment (total hours worked) lags decreasing production in a recession, the rate of productivity growth will tend to slow or go negative. The opposite is true in economic recovery – when production recovers at a faster pace than employment, productivity will tend to increase.
In the following chart we compare manufacturing output (OUTMS) with employment (MANEMP) within the manufacturing sector. The relationship between these two sets of data as shown on the chart, closely simulate the relationship between BLS figures for manufacturing output, hours worked and the resultant labour productivity.
Labour productivity slowed in 2006 when production and employment moved parallel for a period of time. Then productivity started to accelerate before the onset of the recession (shaded area) in 2007 as production increased and employment started to decrease. During the recession period, production drop at a faster rate than employment, causing a significant reverse in productivity growth rates that moved into negative territory for much of 2008. It did not happen because workers suddenly became less productive but simply because demand plunged, followed by a faster decrease in production than employment. The opposite happened when production bottomed at the end of 1st quarter of 2009 and moved sharply upwards while employment was still decreasing. Employment bottomed at beginning of 2010 but its rate of increase was much slower than that for production, resulting in increased productivity. Once demand started to slow down in 2011, employment started to catch up with production and the productivity growth rate started to slow.
The chart below, which timeframe includes the 1973 and early 1980 recessions, shows the close relationship between retail sales, productivity (nonfarm - all persons) and subsequent recessions. It seems to indicate that significant changes in retail sales do have a direct and near immediate impact on productivity. As retail sales slow so does productivity. This relationship weakened in subsequent decades, probably because employers could respond more swiftly to a drop in demand by reducing the work force and working hours at a faster pace.
From the above it seems obvious that the significant increases and decreases in the growth rate of productivity can hardly be attributed to any sudden and significant changes in the productiveness of labour. The plunge in productivity growth in 2008 (and prior recessions) is closely related to the fact that production can be shut down faster than employment. The opposite is also true, production can be increased (at least for a while) without increasing employment at the same pace by using the idle time of existing workers better and secondly, to expect more from existing workers who are under severe pressure to hold on to a job. Once employers formed the opinion that demand growth had returned in 2010, they started to employ again but they were wary of the sustainability of demand and re-employment occurred at a much slower pace. While this gap between production and employment increased, productivity increased – that’s pure logic. However when demand (as shown here in the real retail sales charts above) started to stagnate, the gap between production and employment stopped growing resulting in lower productivity growth.
What does the above tells us about productivity and economic growth:
1. Weak productivity did not cause the recession in 2007 nor was it the cause of previous recessions or the current slowdown in 2011. As shown above, productivity was growing at a high rate just before the onset of the Great Recession. The drop in demand as reflected in “real retail sales” caused production to fall, followed by a drop in productivity. The same scenario may be unfolding in 2011 although on a more mundane scale.
2. A rise in productivity will not solve the slow growth problem without removing or adjusting the structural constraints that limits growth in demand. In fact, the relative high growth in productivity in 2009 and 2010 rather contributed to the widening imbalance between supply and demand because the fruits of increased productivity were not evenly distributed between workers and employer corporates. Profits of most of the big US corporates increased quickly from the end of 2009, not only because of increased productivity (output/labour hours) but also from the benefit of lower real wages. Employment did not only lag the increase in production since early 2009, but the real median income of American workers decreased at the same time, causing a chain of events that will eventually show up in falling demand. Most of the fruits of higher productivity are locked up in corporate profits. These profits are not invested in productive capacity nor is it spent on labour or consumables. This may be good for stock prices in the short run but not for the economy as a whole. Once government stimulus tapers off and unemployment benefits are reduced or limited, the negative effects from the above will show up in demand.
3. Significant changes in demand are the primary drivers of most recessions and recoveries. Productivity is an important factor in the long term growth and a country’s relative competitiveness, but a sustainable recovery or change to faster growth will mostly depend on rising median incomes and job growth.
4. The current hype over low productivity is misplaced and it focuses the attention on issues that have little to do with the current slow growth. US productivity growth in the last decade has outperformed the previous five decades, yet it resulted in the decade with the lowest growth.
5. The factors that influence productivity most over the short term is increasing or decreasing demand which have a direct impact on production volumes. Once a steady increase in demand can be established, an increase rate of productivity growth is likely to follow. Innovation, mechanisation and technology cannot become the primary drivers of growth while demand is stagnating.
Conclusion
Private enterprise has only itself to blame for the current economic crisis and governments’ flawed policies to solve it. Our attempts to influence and control governments has come full circle. Governments today don’t have the independence of mind and integrity to do what is right for the nation as a whole. To criticize and blame them is meaningless. We are all complicit in creating mindless puppets and there is no indication that competition for the puppet master has abated.
Growing demand is probably the only force that can pull us out of the current slow growth environment. Sustainable growth in demand cannot be achieved by higher productivity, more public debt, bailouts, money creation or government stimulus. The solution is to create a sustainable increase in demand without a comparable increase in the supply of goods and services.
That, unfortunately, cannot be achieved by private investment. Private enterprise does not easily invest without the promise of a relative quick return. Private investment aims to produce and sell goods and services (new supply) at a higher value than what they will pay for wages (new demand) or any other input. The end result will be an increase in unutilised capacity and a larger imbalance between supply and demand.
It is up to governments to do the job but they have neither the independence of mind to tackle the much needed structural reforms nor the money to invest in selective capital projects. Their public debt has already reached unsustainable levels and it would be unwise to increase it. Creating more jobs and lifting consumption expenditure without a significant impact on government debt will be difficult to achieve. We have reached a stalemate position. Kicking the can down the road has now become the default solution.
We will discuss possible solutions in later blogs but note that the best solutions may not be the most popular with big business. If it was it would have been pursued by the lobbyist and implemented long ago. However, before we pursue these unpopular solutions to map a way to recovery, we have to face up to the underlying and dominant causes of the economic crisis that started long before the beginning of the Great Recession of the 2000’s.
Since the booming decades of the 1950’ and 1960’s, the US and world economy are in a downward growth trend, weakening with each passing decade. One of the most relevant questions must be; where did the demand go? In our next blog we will expand on the above trend and its relationship with productivity, distribution of productivity gains and taxation, covering the period from 1920 to 2010.
© Copyright David Collett 2011.
Whilst every effort was made to ensure the accuracy of this article, neither this document; nor its author, David Collett; nor any publisher of this article; offer any warranties (whether express, implied or otherwise) as to the reliability, accuracy or completeness of the information appearing in this article. Neither do any of the above parties assume any liability for the consequences of any reliance placed on opinions expressed or any other information contained in the above article, or any omissions from it. Its content is subject to change without notice. Any information offered, is intended to be general in nature and does not represent any investment or business advice of any nature whatsoever. If you choose to rely on such information you do so entirely at your own risk. Neither David Collett nor any third party involved in publishing this article, assume any responsibility or liability for the outcome of such reliance.
-- Posted Friday, 18 November 2011 | Digg This Article
| Source: GoldSeek.com
