Download Productivity

Manager of the
TCW, MetWest,
and TCW Alternative
Fund Families
INSIGHT
VIEWPOINT
Productivity: The Linchpin of the
Global Growth Struggle
TYLER TUCCI | MARCH 18, 2016
Tyler T. Tucci
Assistant Vice President
U.S. Fixed Income
Tyler Tucci is an Assistant Vice President
in the U.S. Fixed Income Rates group.
Mr. Tucci trades foreign exchange
products and is also responsible for
assisting in the evaluation of interest
rate derivatives and global monetary
policy. Prior to joining TCW in 2015, Mr.
Tucci was a Short Term Markets and
Interest Rate Derivative Strategist at the
Royal Bank of Scotland. Mr. Tucci has
completed level I of the CFA exam and
Levels I & II of the CMT exam. Mr. Tucci
holds a BA in Economics and Finance
from Elon University.
Despite three rounds of Quantitative Easing, trillions of dollars of governmental
liquidity injections and historically easy interest rate policy, the U.S. has failed to
generate the growth recovery following the 2008 recession that most had expected
at the outset. While some of this growth slowdown may be explained away as cyclical
and thus temporary, recent empirical work highlights a drop-off in productivity
growth beginning in 2004 as a more likely culprit. Productivity growth, a measure
of output per unit of input, has re-entered the forefront of U.S. economic debate as
of late as global wage pressures remain muted despite the U-3 unemployment rate
reaching 4.9%. This is somewhat of a surprise to economists because according to
the Taylor Model used by the FOMC, as actual output converges on potential output
inflationary pressures should increase. Said differently, there has been a strong link
between productivity and compensation historically as increases in productivity
have improved the value of labor thus increasing the demand for labor. Previous
Federal Reserve estimates would have concluded 4.9% unemployment was below
the non-accelerating inflation rate of unemployment (NAIRU) and thus should have
generated some upward pressure on wages as labor supply slack diminishes. NAIRU
is a theoretical threshold at which the economic supply and demand for labor are
balanced, which keeps inflation from increasing. It is this confidence in the existence
of NAIRU and its impact on wages and inflation that led FOMC Chair Yellen to
tighten policy in December. However her faith in NAIRU has looked less than
justified at this point as further reduction in labor market slack in 2016 has failed
to yield much upward wage pressure. Unfortunately, both productivity and wages
have been moving in reverse as of late, as shown by a recent San Francisco Fed
paper examining the sluggish rise in wages and compensation.1 The SF Fed research
team found that over the past two years, average wage growth across four separate
measures of wages (average hourly earnings, employment cost index (ECI) for
wages and salaries, median weekly earnings, and compensation per hour) have been
hovering around 2.25%. Despite continued robust labor market data, the current
measure of this average of indicators pales in comparison to the 3.25% average wage
growth seen from 1983 to 2015.
1 Daly, Mary C., Bart Hobijn, and Benjamin Pyle. “What’s Up with Wage Growth?” Federal Reserve Bank of San Francisco. Mar. 2016.
VIEWPOINT
Productivity: The Linchpin of the Global Growth Struggle
the macroeconomic environment changes meaningfully. In
his 2014 NBER working paper,4 Robert Gordon concluded
that because of slower future output growth and thus less tax
revenue, the Congressional Budget Office’s current estimate
for the 2024 Debt/GDP ratio is understated by 9% (78%
vs 87%). 5 The author notes “My estimate of 1.6 percent
for the current rate of potential real GDP growth is almost
exactly equal to realized actual real GDP growth in 2004-14,
implying “more of the same” rather than a radically new
economic environment. The 1.6 percent potential growth
rate is almost exactly half of the realized growth rate of actual
real GDP between 1972 and 2004; of this difference, roughly
one-third is due to slower productivity growth and the other
two-thirds to slower growth in aggregate hours of work.”
His conclusions suggest the U.S economy may eventually
have issues servicing a debt burden in excess of 100% of
GDP if his projected shortfall is realized. If other developed
countries also see similar budget shortfalls due to the fall in
productivity, globally monetary policy may be forced to remain
easy for far longer than expected.
It may be no coincidence then, that during a similar period
that saw total compensation fall; productivity growth in the
United States has also fallen to an average rate of just 1.2%
percent, down from 2.1% between 1974 and 2007.2 This
drop off is consistent with the findings of researchers at the
New York Fed who estimate that U.S. productivity started
to slow in 2004, before the Great Recession. Until recently,
a common argument to explain away this slowdown as
anything other than economic weakness is that productivity
has been mis-measured because output data hasn’t adjusted
for better quality and more efficient products produced over
the past decade.3 However, in his recent working paper on
productivity measurement, Professor Chad Syverson of the
University of Chicago argues that this is not the case. Instead,
he finds that since the productivity slowdown occurred in
dozens of countries with varying technology sector size,
the size of the slowdown is unrelated to measures of the
countries’ consumption or production of information and
communication technologies. His findings show that the
decrease in productivity seen over the past decade caused
U.S. GDP to be 15% lower than it would have been otherwise.
However, since digital technology industries only comprised
7.7% of GDP in 2014, it would be impossible to explain all
15% away as technology related. Ultimately, it may indeed be
the case that adjustments need to be made to productivity
measures to account for advancements made in technology,
but it appears unlikely that these changes are descriptive of
the entire fall in productivity seen since 2004.
The lack of a concrete recovery in output growth post
2008 has given voice to critics who claim that this fall in
productivity is a function of secular stagnation and not merely
a more drawn out recovery. The term secular stagnation was
coined by Alvin Hansen in 1938 after the Great Depression
and refers to a period that results in poor economic progress
as a result of limited investment opportunities or periods that
require negative real interest rates to achieve full employment.
Recently, former Treasury Secretary Larry Summers has
revived the secular stagnation mantle as a way to explain
the poor levels of output growth globally that have persisted
since 2008. In his current iteration of secular stagnation, it is
argued that post-recession industrialized economies suffer
from an imbalance stemming from an increased propensity
to save at the expense of the propensity to invest. As a result
of this excess level of savings, overall demand decreases,
reducing growth, inflation and the real rate of interest. While
the validity of this theory is hotly contested, it is somewhat
supported when examining U.S. nominal interest rates and
M2 money velocity, which both sit at or below the lowest level
seen in the last 50 years.
This concerning trend in falling productivity also helps to
explain the recent downward trend in U.S. GDP growth, which
has caused some to surmise that potential growth in the
U.S. is now lower than before the recession in 2008. Given
the lack of inflation the U.S. economy is generating, some
market participants explain away the recent bout of poor
economic growth by suggesting that the output gap between
current growth and potential growth needed several more
years to close post crisis. This thesis has not yet proved true
as U.S. economic growth has been generally disappointing
in the years following 2008. Alternatively, if recent empirical
studies are indeed reflective of future conditions, we should
expect economic growth to remain stuck in neutral unless
2 Kahn, James, and Robert Rich. “The Productivity Slowdown Reaffirmed Liberty Street Economics.” Liberty Street Economics. Federal Reserve Bank of New York, 15 Mar. 2016.
3 Syverson, Chad. 2016. “Challenges to Mismeasurement Explanations for the U.S. Productivity Slowdown.” Working Paper 21974. National Bureau of Economic Research. http://www.nber.org/papers/w21974.
4 R. J. Gordon, “A New Method of Estimating Potential Real GDP Growth: Implications for the Labor Market and the Debt/GDP Ratio,” NBER Working Paper No. 20423, September 2014
5 Gordon, Robert J.” NBER Reporter 2015 Number 1: Research Summary. National Bureau of Economic Research, 15 Mar. 2016
2
VIEWPOINT
Productivity: The Linchpin of the Global Growth Struggle
History suggests there are a number of potential remedies
to escape a future of maligned productivity growth.
However, these methods which center on an increase in
capital expenditure in one form or another have been largely
passed over post 2008 in favor of share buybacks or other,
potentially less efficient uses of capital. One such example
of increased capital expenditure helping to break stagnant
productivity occurred in the late 1930’s as a public investment
boom financed by the U.S. government caused a spike in
productivity as factories retooled for World War II. The U.S.
would ultimately spend roughly $350 billion on the war which
not only boosted the war effort, but boosted the post war
economy by approximately tripling of GDP between 1940 and
1950. Unfortunately, there aren’t many similarities to draw
between the post WWII growth boom and today’s economy;
as the figure below shows, firm’s capital expenditures have
fallen to levels usually seen during economic slowdowns,
suggesting a more defensive private sector mentality.
Moreover, in 2014, according to the Conference Board’s Total
Economy Data Base, the growth of total factor productivity
(TFP) hovered around zero for the third straight year, down
from 1 per cent in 1996-2006. This lack of willingness to
spend capital to boost growth at a firm level, combined with
the stagnant growth in the labor force, shown below does not
bode well for future growth.
Despite seemingly clear evidence that current tepid levels of
productivity growth should be expected to persist, suggesting
slow potential growth in the future, the average YoY forecast for
2016 GDP growth remains around 2% according to Bloomberg
Data. This notion that 2016 growth with be roughly equal to 2015
growth is tough to square with the global macro backdrop. In a
scenario where the Federal Reserve still maintains a hiking bias
in 2016, which is still the markets base case despite downward
revision to amount of total hikes, current GDP growth should
not exceed GDP growth during periods of maximum monetary
accommodation. This is because on the margin, higher
borrowing costs decrease the supply of money available which
constricts credit and thus economic growth. Conversely, if the
Fed opts to leave rates unchanged, it is most likely because of
shocks to global inflation or growth which would also suggest
risks to 2% GDP growth in 2016. In either case, it seems that this
notion of stagnant productivity weighing on U.S. growth has only
just entered the conversation and has yet to capture the minds
of market participants at large. However, given that the U.S.
economy has failed to exceed 2.5% YoY real GDP growth in the
last decade, it may be time to move away from previous thinking
and towards a new understanding of the post crisis economy.
Real Gross Private Domestic Investment: Fixed Investment: Nonresidential: Equipment
7.5
5.0
Percent Change
2.5
0.0
-2.5
-5.0
-7.5
-10.0
-12.5
2000
2002
2004
2006
2008
2010
Source: The Federal Reserve Bank of St. Louis
3
2012
2014
VIEWPOINT
Productivity: The Linchpin of the Global Growth Struggle
Gross Domestic Product
20
Percent Change from Preceding Period
15
10
5
0
-5
-10
-15
1940
1960
1980
2000
Source: The Federal Reserve Bank of St. Louis
Employment Cost Index: Total Compensation: All Civilian
1.4
1.2
Percent Change
1.0
0.8
0.6
0.4
0.2
0.0
2002
2004
2006
2008
2010
2012
Source: The Federal Reserve Bank of St. Louis
4
2014
VIEWPOINT
Productivity: The Linchpin of the Global Growth Struggle
Industrial Production Index
30
Percent Change from Year Ago
20
10
0
-10
-20
-30
1920
1940
1960
1980
2000
Source: The Federal Reserve Bank of St. Louis
Personal Saving as A Percentage of Disposable Personal Income
30
25
Percent
20
15
10
5
0
-5
1940
1960
1980
2000
Source: The Federal Reserve Bank of St. Louis
5
VIEWPOINT
Productivity: The Linchpin of the Global Growth Struggle
Gross Private Saving
600
Change from Year Ago, B illions of Dollars
500
400
300
200
100
0
-100
-200
-300
-400
1950
1960
1970
1980
1990
2000
2010
Source: The Federal Reserve Bank of St. Louis
Velocity of M2 Money Stock
2.3
2.2
2.1
Ratio
2.0
1.9
1.8
1.7
1.6
1.5
1.4
1960
1970
1980
1990
2000
2010
Source: The Federal Reserve Bank of St. Louis
This material is for general information purposes only and does not constitute an offer to sell, or a solicitation of an offer to buy, any security. TCW, its officers, directors, employees or
clients may have positions in securities or investments mentioned in this publication, which positions may change at any time, without notice. While the information and statistical data
contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision.
The information contained herein may include preliminary information and/or “forward-looking statements.” Due to numerous factors, actual events may differ substantially from those
presented. TCW assumes no duty to update any forward-looking statements or opinions in this document. Any opinions expressed herein are current only as of the time made and are
subject to change without notice. Past performance is no guarantee of future results. © 2016 TCW
865 South Figueroa Street | Los Angeles, California 90017 | 213 244 0000 | @TCWGroup
6