Replying to a critic

[Added: See Karl's response in the comments ]

Karl Smith writes  In Which I Disagree With Almost Every Word Mike Mandel Says . It’s a long post (though not nearly as long as mine), and I just wanted to reply to two points.

First, Karl says:

The only way to get GDP wrong is either to miscount the number of goods and services sold in the US or to misestimate the price index of final goods – not intermediate goods.

Um, no. This statement is simply wrong.

gross domestic product = exports + gross domestic  purchases – imports.

Imports, as it turns, out, include a lot of imported intermediate inputs ( according to  this piece in the February 2011 Survey of Current Business, “BEA estimates that about 40 percent of imported commodities are used as intermediate inputs by businesses”).   So that getting the price index wrong for imported intermediate inputs slides right into GDP.

More fundamentally,  remember that GDP is a value-added measure. However, the fundamental unit of observation for the BEA each quarter is  revenues/shipments  for various industries, which is a gross output measure. Then the BEA has the herculean task–which I never fully appreciated before–of figuring out how much of each industry’s  revenues is final product, and how much is intermediate input.  A simple example:  Each month the revenues of law firms are reported each quarter  by the Census Bureau. Part of those revenues are final product (personal consumption of legal services), and part are intermediate inputs (legal services to business). Taking the real growth rate of observed revenues as given,  any error in estimating the real growth rate of intermediate inputs of legal services will translate directly into an error in estimating the real growth rate of personal consumption of legal services.

This sort of error does not wash out in final GDP.   Consider the related question  of whether R&D should be treated as business investment or as intermediate inputs. Currently, R&D is treated as an intermediate input, but the BEA has calculated that treating R&D  as investment would boost real GDP growth.

Second, Karl says:

An improvement in the terms of trade, which is what Mandel is identifying, is a productivity improvement for US workers. Its not based on US innovation, but it does lead to more output per US worker

The question is an important one: Is a ‘terms-of-trade’ productivity improvement equivalent to a ‘domestic’ productivity improvement? Here I’m going to cheat: The short answer is that I’m about to finish a theoretical paper showing  the specific sense in which they are not equivalent.  But you will have to wait a couple of weeks for that one…I kind of overdid the last post.

How much of the productivity surge of 2007-2009 was real?

[This post just grew and grew and grew, until it turned into something  ridiculously long. Sorry about that--I'm probably guilty of blog abuse.   If you want, here's a PDF version. I look forward to comments ]


In the 2007-2009 period, the U.S. economy experienced its worst recession since the Great Depression. Nevertheless, despite this deep downturn,  the near-collapse of the financial system and unprecedented global economic turmoil,  U.S. productivity growth actually seemed to accelerate in the 2007-2009 period, or at least maintain its previous pace.

The 2007-2009 productivity gain had a major impact on both economic policy and political discourse. First,  it gave the Fed a free hand to feed mammoth amounts of liquidity into the system without worrying about inflation.  Second, it convinced the economists of the Obama Administration that the economy was basically sound, and that the big problem was a demand shortfall. That’s why they expected things to get back to normal after the fiscal stimulus.

However, I’m going to show in this post that the  productivity gain of 2007-2009 is highly suspect.  Using BEA statistics,  I identify the industries that contributed the most to the apparent productivity gain, including primary metals, mining, agriculture, and computers and electronic products. Then I analyze  these high-productivity growth industries in detail using physical measures such as barrels of oil and tons of steel. I conclude  these ‘high-productivity’ industries did not deliver the gains that the official numbers show.

Based on my analysis, I estimate that the actual productivity gains in 2007-2009 may have been very close to zero.  In addition, the drop in real GDP in this period was probably significantly larger than the numbers showed.  I then explore some implications for economic policy.


I start by giving several  data points.

*From 2007 to 2009,  business productivity rose at a 2.4% rate, according to the official data. By comparison, the productivity growth rate was only 1.2% over the previous two years (2005-2007).

*If you like your numbers quarterly, business productivity grew at a 1.8% annual rate from the peak in 07IV to the trough in 09II.  That’s somewhat faster than the  1.6% growth rate of the previous 3 years.

*Looking at  total economy productivity–real GDP divided by full-time equivalents (FTE)–we see that productivity growth in 2007-2009, at 1.6% per year,  was double that of the previous two years (0.8% per year).

This chart breaks down productivity growth by business cycle, using the official statistics. You can see that the productivity growth of the 2007-2009 period–the worst recession in 70 years–appeared to be basically a continuation of the productivity gains during the boom. You can’t tell from this chart that anything bad happened to the economy.

The strong measured productivity growth during the crisis years reflects a steep drop in employment (-5.7%) combined with an apparently mild two-year decline in real GDP (-2.6%).  Of course, ‘apparently mild’ is still nastier than any post-war U.S. recession, but a 2.6% decline in real GDP translates into a 4.4% decline in per capita GDP, which puts the U.S. at the low end of  financial crises described by Reinhart and Rogoff.

What’s more, the 2007-2009 productivity gain had a major impact on both economic policy and political discourse. First,  it gave the Fed a free hand to feed mammoth amounts of liquidity into the system without worrying about inflation. 

Second, the productivity gains convinced the economists of the Obama Administration that the economy was basically sound and there was nothing wrong with  the ‘supply-side of the economy.  Instead, the Obama Administration concluded that the big problem was a demand shortfall, which is why they expected things to get back to normal after the fiscal stimulus.

Consider this April 2010 speech from Christina Romer, then head of the CEA. She said:

The high unemployment that the United States is experiencing reflects a severe shortfall of aggregate demand. Despite three quarters of growth, real GDP is approximately 6 percent below its trend path. Unemployment is high fundamentally because the economy is producing dramatically below its capacity. That is, far from being “the new normal,” it is “the old cyclical.”

Perhaps more important from a political perspective, the productivity surge  helped convince the Obama economists that the job loss was ‘normal’ in some sense. That is, the rise in productivity suggests that the financial crisis apparently just accelerated the normal process of  making U.S. businesses leaner and more competitive, and there was no structural problem. In fact, that’s what Romer said in her speech:

In short, in my view the overwhelming weight of the evidence is that the current very high — and very disturbing — levels of overall and long-term unemployment are not a separate, structural problem, but largely a cyclical one. It reflects the fact that we are still feeling the effects of the collapse of demand caused by the crisis. Indeed, at one point I had tentatively titled my talk “It’s Aggregate Demand, Stupid”; but my chief of staff suggested that I find something a tad more dignified.

If productivity was rising, then the job loss was due to a demand shortfall and could be dealt with by stimulating aggregate demand. That, in turn, helps explain why the “job problem”  didn’t seem so urgent to the Obama administration, and why they spent more time on other policy issues such as healthcare and regulation.

[Read more...]

An Interesting Education Spending Chart

As I was revising my intro economics textbook, I came on an odd education fact. I don’t know quite how to interpret it, but it seems interesting.  The chart below shows the share of consumer spending on education, by income class.

What’s interesting that the top 20% of households have dramatically increase the share of their spending that they devote to education, from 1.8% in 1999 to 3.1% in 2009. Meanwhile, the other income quintiles have seen a much smaller increase in education’s share. For example the third quintile–the “middle class” –has  only increased education spending from 1.1% to 1.5% of their budgets.

There are of course all sorts of potential explanations. The top quintile are more likely to send their kids to expensive private colleges; the middle income quintiles are more likely to get financial aid;  the middle income quintiles don’t have the resources to send their kids to college, and so forth. Take your pick.  

But even if we don’t know the reason, we know the implication: Education spending is increasingly concentrated in the high-income backet. The top quintile accounted for 56% of all consumer spending on education in 2009.  That makes education spending one of the most ‘top-heavy’ spending categories.  Is this a sign that high-income households are the only ones who can afford to pay for college? Or is a sign that higher-income households are being soaked?  Your choice.

The End of Japan as an Industrial Power?

I don’t mean to be apocalyptic here,  in the face of the terrible tragedy hitting the Japanese people.  But I think the current crisis is going to accelerate the aging of Japanese society, especially if the nuclear disaster gets worse.  And  I’m wondering whether we are seeing the beginning of the end of Japan as an industrial power. 

Think about this from the perspective of an executive running a major Japanese manufacturer.  In the short-term, when you are facing all the problems at home,  you may find it appealing, wherever possible, to ‘temporarily’ switch over much of your production to either China or the U.S., your two major markets.  This can be justified, patriotically, as the need to keep up profits to help fund the reconstruction of Japan.

But you may not want to move that  production  back again. In the medium-term,  as you consider how much to invest in rebuilding your factories and infrastructure in Japan,  you will face a demographic problem–the coming collapse of the working-age population. Take a look at this chart:

Basically,  Japan’s working-age population is anticipated to drop by 20% over the next 20 years. And that actually understates the problem in the rural areas, which have felt a youth drain to the big cities. ( see here and here   ). 

That makes it much more attractive to invest in China and the U.S., of all places, which have more desirable demographics for both the workforce and consumption. Ten years from now, much of what is made in Japan today will be made elsewhere.  

A Decade of Labor Market Pain

In February 2001, nonfarm payrolls hit their business cycle peak of  132.5 million. Ten years later, the latest data pegs February 2011 payrolls at 130.5 million, a 1.5% decline. To put this in perspective, the ten-year period of the Great Depression, 1929-39 saw a 2.3% decline in nonfarm employment, roughly the same magnitude.

But even that 1.5% understates the extent of the pain for most of the workforce. I divide the economy into two parts. On the one side are the combined public and quasi-public sectors, and on the other side is the rest of the economy. Public, of course, refers to government employees.  ‘Quasi-public’, a term I just invented, includes the nominal private-sector education, healthcare, and social assistance industries. I call them ‘quasi-public’ because these industries depend very heavily on  government funding. For example, social assistance includes ‘child and youth services’ and ‘services for the elderly and disabled’, which are often provided under government contract.

The chart below shows employment growth in the public/quasi-public sector, compared to employment growth in the rest of the economy, with February 2001 set to 100. We can see that public/quasi-public employment rose steadily over the past ten years, and is now up 16%. By comparison, the rest of the private sector  is down 8% in jobs over the past 10 years. 

Once again, we look at the Great Depression for an analogy. From 1929 to 1939, government employment rose by about 30%. If we back that out, then private sector non-ag  jobs fell by 6%  over the Depression decade. That compares to the contemporary 8% decline in private non-ag non-quasi-public jobs since 2001.  So by this measure, the past 10 years have been worse for the labor market than the decade of the Great Depression.

Now let’s look by state. I put the chart beneath the fold, because it’s long and weird and I’m not sure if it going to come out right.

[Read more...]

Fox vs CNN

I don’t usually do media criticism. But flipping channels on the Japan earthquake meltdown coverage, I  have to say that Fox was just so much more watchable and informative than CNN.  The CNN anchors and reporters spent an awful lot of time congratulating each other, and they often sounded ill-informed. The Fox folks drilled right in on the information and the pictures, and I felt like they were focused on the event rather than themselves.  (I was watching the feeds at my Los Angeles hotel).

BTW, I did not evaluate MSNBC or CNBC.

Regulation as Congestion

I’ve been thinking a bit more about the analogy of regulation as throwing small pebbles into a stream, and if you throw too many pebbles in, the stream can be dammed up.

Maybe this is related to the idea of congestion pricing in transportation. Each additional vehicle imposes a negative externality on other vehicles using the same road, so many transportation economists have supported the idea of using variable tolls or congestion pricing to give drivers the correct incentives.

In the same way, maybe we can give regulators better incentives by adjusting cost-benefit analyses for the negative externalities of regulation. The question then is the size of the negative externality factor.

Traffic engineers tend to study congestion using turbulence models. These models can give a variety of different behaviors, include sharp shifts in phase where traffic suddenly shifts from free-flowing to congested to stopped. I do wonder whether there is an analogy for regulation…hmmm.






Some Thoughts on ‘Bill Shock’ and Negative Externalities

In my paper on the Regulatory Improvement Commission, I argued that adding new regulations was like  tossing small pebbles into a stream. Each pebble by itself would have very little effect on the flow of the stream. But throw in enough small pebbles and you can make a very effective dam.

Why does this happen? The answer is that each pebble by itself is harmless. But each pebble, by diverting the water into an ever-smaller area,  creates a ‘negative externality’ that creates more turbulence and slows the water flow.

Similarly, apparently harmless regulations can create negative externalities that add up over time, by forcing companies to spending  time and energy meeting the new requirements. That reduces business flexibility and hurts innovation and growth.

For example, consider the ‘bill shock’ regulations now under consideration by the FCC.  ‘Bill shock’ is when someone gets a mobile bill that is higher than they expected—say, a large roaming charge.  This problem is annoying but not life-threatening.

In response to consumer complaints, the FCC  invited comments on  regulations that would require “customer notification, such as voice or text alerts, when the customer approaches and reaches monthly limits that will result in overage charges,” and ” require mobile providers to notify customers when they are about to incur international or other roaming charges that are not covered by their monthly plans, and if they will be charged at higher-than-normal rates.”

One question is whether bill shock is a widespread problem. A just-released study, “An Empirical Analysis of Overages on Wireless Consumer Bills” by Recon Analytics suggests that most overages are relatively small and not repeated.  What’s more, in many cases it makes financial sense to take a small overage, rather than switch to a more expensive plan. The study reports that “only 0.3% of wireless accounts go into overage during a year by such an amount that the customer would have been better off having upgraded their plan for that year.”

Now, here’s where we come to the tale of the pebble and the stream.  The rule of thumb about IT projects is that they are always more complicated and take longer than you think.  More precisely, it would be a major and costly effort to build a system that in real-time accurately tracks customer total charges on the home system and on domestic and international roaming systems.  The key words here are ‘real-time’ and ‘accurate’ in the same sentence—the two together translate into expensive.

The bottom line is that if the bill shock regulations are enacted, significant resources—IT personnel and dollars–would be diverted into building and maintaining this real-time/accurate charge tracking system. The number of beneficiaries—the people who are truly surprised by ‘bill shock’– would be relatively small.

What’s more, these are resources that would not be available for innovation and improvements to the whole network.  This negative externality—the potential slowdown in innovation and the pace of network improvements– is not measured as part of conventional cost-benefit analysis. Depending on how many other regulations are being enacted, it could be another pebble that helps dam up the stream.

Indeed,  this suggests we should not evaluate regulations one at a time, but rather as part of a larger context. Think of the impact of a regulation as the net benefit of that regulation plus a negative externality E. That negative externality sums over all regulations on that industry.  The more regulations, the bigger the negative impact.

From that perspective, in order to meet President Obama’s goal to eliminate regulations that hurt job creation, conventional cost-benefit analysis is not enough. Agencies such as the FCC need to  look skeptically at the bill shock rule and other borderline regulations that could impose genuine negative externalities on job growth and innovation without helping many people.

Coming Event: The Real Story about Investment and Savings

Back in January, I promised to start running lunchtime events on interpreting economic statistics in the new global economy.

I’m ready for the first one– “Lunch at PPI: The Real Story about Investment and Savings.” The blurb is below–and when we say seating is strictly limited, we mean it. RSVP to

Lunch at PPI: The Real Story about Investment and Savings

Dr. Michael Mandel will lead a lunch forum for journalists and policymakers to discuss key trends in U.S. and global savings and investment, with the goal of identifying potential story ideas and policy opportunities. Topics will include why investment in physical, human, and knowledge capital is essential for the future of the U.S. economy, and an examination of why the government data measuring savings and investment are woefully incomplete and misleading. Dr. Mandel is a senior fellow at the Progressive Policy Institute, formerly award-winning chief economist at BusinessWeek. Strictly limited seating.

Date: March 21
Time: 12 noon
Progressive Policy Institute
1730 Rhode Island Avenue NW Suite 308
Washington DC 20036



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