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Us economy, productivity and the Bush boom
Gerard Jackson
While current indicators have persuaded me that the Australian economy is facing, in the absence of a deus ex machina, an impending recession the same cannot be said of the US economy. Indicators suggest that the economy has some way to go before it reaches the peak of the boom.
While productivity in Australia has been falling as unemployment falls, the reverse has been happening in the US. Since the 2003 tax cuts the establishment survey shows that 4.2 million jobs have been created which is very close to the household survey of about 4.6 million.
What I find interesting is that though unemployment has fallen to 4.9 per cent (the official figure for Australia is 5.1 per cent) productivity has still been racing ahead, unlike Australia where it has been dropping for more than 12 months.
Some commentators believe that as more people enter the labour force productivity is bound to fall and that this is a measure of success rather than a bad economic omen. This opinion merely shows that supply and demand analysis is not as straightforward as many people, some of them with economics degrees, seem to think.
What they have in mind is a graph showing a decline in productivity as the supply curve moves down the demand curve while the demand curve shifts more slowly to the right, thereby ensuring that wages rates still rise but at a slower rate. This leads them to conclude that falling productivity always signifies that the capital-labour ratio has fallen.
However, there is no need for this to happen. If per capita investment continues to rise faster than the labour supply than productivity will rise instead of falling. Looked at from this angle booms that are allowed to run their full course need never suffer falling productivity before the bust. So why do they?
A genuine investment boom is one that is fuelled by genuine savings. By this we mean one in which income that would have been spent on consumption is used to redirect resources to the production of future goods, meaning capital goods. In this situation any reduction in spending on consumer goods is matched by similar increase in spending on producer goods which later leads to increased productivity and output.
This is why we can say that saving is the process by which we transform present goods into future goods. But along comes someone who tells us that this is all baloney and claims that “Credit expansion performs the miracle . . . of turning stone into bread” (Paper of the British Experts, 8 April 1943).
The result is that the central bank forces interest rates down below their market clearing levels which then sparks a boom as business uses the newly created credit to go on an investment spree for which there is no real savings. Eventually bottlenecks caused by distortions in the capital structure emerge along with all manner of shortages, the current account deteriorates, labour costs begin to rise as productivity starts falling and manufacturing begins to shed labour despite the aggregate demand for labour continuing to rise. Finally the boom is brought to an end.
According to this analysis the fall in productivity that precedes the bust is a symptom of a monetary disturbance and not due in anyway to an increase in the labour supply. If it were caused by an expanding labour supply why do wages rise instead of falling?
I know there are those of you out there who claim that this monetary explanation does not apply to you because you are not Keynesians, you simply believe in maintaining a stable price level. The failure here is to recognise that money is not neutral. This error results in the failure to see that price stabilisation policies are no different in principle from Keynes’ nostrum about “turning bread into stone”
I should finish with the comment that there should be no doubt that President Bush’s capital gains taxes have had a remarkably beneficial effect on the economy. This fact, however, should not be allowed to blind us to the egregious error that justifies the manipulation of the money supply.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 9 January 2006