[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.