Labour productivity: A depressing tale

The OECD has just publised a productivity compendium, full of great information.  Here's a Figure, Figure 6.1, showing output per hour for a number of countries, trying to calculate its trend via averages

Labour productivity is defined here as GDP per hour worked. Its decomposition into a trend and cyclical components is done in two steps. First, average annual growth is calculated for each cycle, where the economic cycle is defined using the chronology of turning points in the OECD's Composite Leading Indicators. Second, the individual average growth rates for a given cycle are linked so as to develop a time series of smoothed trend. The smoothing follows a geometric average, assuming that annual labour productivity growth is constant between the mid-points of each cycle.

Here are the results and my interpretation.
1. France, Germany and Italy: the trend productivity growth is falling, even before the recession.  This is very worrying.

2. the UK jumped up in the late 80s, 90s, 00s.  So that was good.  Likely a combination of the supply side reforms in the early 1980s which enabled the speedy diffusion of ICT (Nick Crafts makes this argument).  The snag is that labour productivity growth has now fallen very sharply.

3. The US acceleration came in 1995, which boosted it up to UK levels.  But the US decelaration in the   2010s is much less.

Various teaching links

Price gouging still with us
http://cheaptalk.org/2012/10/29/price-gouging/

Science key to growth
http://www.nytimes.com/2012/10/29/opinion/want-to-boost-the-economy-invest-in-science.html

World data visualisation
http://marginalrevolution.com/marginalrevolution/2012/10/visualization-data-for-world-development.html

Too big to fail still with us and what to do
http://economix.blogs.nytimes.com/2012/11/01/too-big-to-fail-remains-very-real/#more-157343

Various teaching links: How to know more than the next guy.

There’s an old joke about two men in a forest trying to get away from a tiger.  One puts on an old pair of running shoes.  “You can’t go very fast in those” says the other.  “I only have to go faster than you” says the first. 

Regrettably,  much of life is being faster than the next guy.  So here’s a lesson in how to get ahead, drawn from the report into the West Coast Mainline bidding fiasco, which I just saw here.

As you remember, the bidding process collapsed in ignominy and will have to be rerun following the admission of errors in the process by the Department for Transport (DfT) who conducted the bids.  The inquiry into the fiasco has a preliminary report out.  I read the following lessons.

1.      The bidding works like this.  The winner of the bid gets all the revenues from the line they operate.  But, they have to pay a per year fee to the DfT to operate the line.  The DfT recognizes, correctly, that revenues might rise or fall depending on general economic activity which cannot be foreseen.  Thus there is an adjustment formula that adjusts the fee in line with GDP, in particular reducing it if GDP falls.  So you can win the bid by offering a large fee, knowing that the fee will fall if unexpected bad times come along.

2.      At the same time, the DfT does not want the franchiesees to go bust.  So you can also win the bid by offering to hold a lump sum of money, which payable to the DfT in bad times.

3.      What’s key for the bidders is to know whether they can win by offering:

a.       to hold a large lump sum, but bid a low fee

b.      bid a large fee, but hold a small lump sum

4.      The DfT have an economic model, which tells them the answer i.e. if  a bidder decides to adjust the lump sum, how much they can vary the fee..   Here’s what went wrong.

a.       they were unwilling to show the model to the bidders who were just given a number telling them the trade off between lump sum and fee.   As it turned out, that number was not based on the model at all, but on some other procedure kept secret from the bidders.

b.      The model worked out payments in real terms, in 2010 prices.  But the DfT thought the model results were in nominal terms.  So bidders were given a figure for what they were told was an adjustment in nominal terms (see paras 5.14.3).  This gave them the wrong price.  This matters since the bids last for five years.   So if you are told to make an adjustment of £X in 2015 and that mistakenly in real terms, it can drastically understate the correct nominal figure (by the compounded price change over 5 years).  As the report says 5.15. “Had they been converted into the nominal terms, which they should have been, significantly increased [adjustments] would have been required”

So here’s how to get ahead by knowing more than the next guy.

1. A nominal number is in pounds, e.g. my salary was £400 per week last year and £420 this year, a rise of 20/400=5%
2. A price index tells you how much the average basket of goods costs from year to year e.g. the basket costs £200 last year and £210 this year, a rise of 10/200=5%.  
3. Since wage and prices have risen by the same, the “real” wage is unchanged.  Since a numbers in real terms is the nominal number divided by the price index and index of the real wage is £400 last year and £400 this year.

Various teaching links

1. Distinctive capabilities.
A marvellous example from the FT today using Kay's capability analysis on the failure of the London black cab manufacturers Manganese Bronze.  Their two capabilities: regulation and reputation, ran out. Interesting articles here, pointing out for example:

"2007 was the last year the company turned a profit. While Manganese Bronze had updated its cabs over the years, they were still being built on a basic structure that traced its heritage back to the first black taxi, dating from 1948.  Despite its outdated product, the company enjoyed a protected market because of a rule that London taxis have a 28ft turning circle.

But by 2008, the TX4 faced serious competition from Mercedes-Benz’s Vito, which met the 28ft circle rule but was more fuel-efficient and cheaper to run.  In just over four years, the car has captured 38 per cent of the London market"

2.  Adjustment along many margins
In our supply and demand models, price and quantity adjust to restore equilibrium.  But what if they, due to regulation for example, cannot adjust and are not at the equilibruim point?   The lessson of economics is that in such a market there is an opportunity to trade.  So its likely that there will be some other form of adjustment.  Here's a great example from Tim Taylor on rent control.

Is British Growth Held Back Due to Small Cities?

The Economist thinks so: larger cities would raise learning, communication of ideas etc.

The SERC is not so sure:

"City size and diversity, however, provide an economic payoff: a critical mass of people, resources and ideas help produce agglomeration economies
(Glaeser 2011). Increasing that critical mass helps raise productivity, therefore: the consensus
from recent studies is that doubling employment in a city raises average labour productivity by
around six percent, although these effects are much more important for some types of economic
activity(Melo, Graham et al. 2009). They are much more important in precisely those sectors of
economic activity in which the British economy is specialised and our most prosperous cities – the Londons, Cambridges and Oxfords – are particularly specialised: skill intensive traded services.

 Although urban density is strongly correlated with the effective or functional size of a city there is no evidence that density itself is a cause of these observed agglomeration economies. It seems more likely that density is the outcome of agglomeration economies as both households and firms bid up the price of land to benefit from them thus causing development to be at higher density. Indeed Cheshire and Magrini (2009) find that once all other factors including city size are controlled for, higher density is associated with slower urban economic growth."

And they have interesting examples:

Two examples illustrate the difficulty of separating out density effects. 1) Building CrossRail, for example, will likely reduce the density of the London region as a whole as people take advantage of quicker travel to
move out to cheaper land. But it will still increase the effective size of London since with easier travel the costs of productive interactions between economic agents will fall and their potential number will increase. 2) Take two cities with identical populations and borders: building more houses will increase density. But it is then hard to attribute any subsequent economic changes to higher density, since population size has also gone up.

How the UK can recover: Nick Crafts has the answer

Nick Crafts gave the RES policy lecture on 18 October.  He's right on almost everything: here's what he has to say

If fiscal consolidation continues and radical changes to monetary policy are ruled out, it is mainly ‘supply-side’ reform that can restart UK growth without doing longer-term damage to the economy. Among other things, that means repairing infrastructure, improving education, reforming taxation and tackling the restrictive planning system.

And here's the answer

But one area that could deliver both short-term stimulus and long-term efficiency is private house-building – as happened in the 1930s recovery from recession. Today’s planning restrictions mean that the stock of houses is three million below and real prices are 35% above what they would be if market forces operated freely.

Slides of Nick Crafts’ RES Policy Lecture.