Competition and firm productivity

Using data on Portuguese firms this new working paper looks at the relationship between competition and firm productivity. And, not too surprisingly, finds a positive relationship between competition and both total factor productivity and labour productivity.

Competition and Firm Productivity: Evidence from Portugal

Pedro Carvalho

Abstract:
This paper presents empirical evidence on the impact of competition on firm productivity for the Portuguese economy. To that effect, firm-level panel data comprising information between 2010 and 2015 gathered from the Integrated Business Accounts System (Portuguese acronym: SCIE) is used. The database enables the construction of economic and financial indicators, which allow for isolating the impact of competition on firm-level productivity. We find a positive relationship between competition and both total factor productivity and labor productivity. This relationship is found to be robust to different specifications and in accordance with the results in the literature obtained for other countries.

The determinants of productivity

From VoxEU.org comes this short video in which Professor John Van Reenen discusses the impact of management on productivity.

Competition can foster productivity by eliminating unproductive firms out of the market. John Van Reenen discusses the impact of management quality on productivity - and how this is influenced by market forces. This video was published by the CORE Project.

On the link between US pay and productivity

From VoxEU.org comes a column by Anna Stansbury and Lawrence Summers on the relationship between pay and productivity in the US.

Since 1973, there has been divergence between labour productivity and the typical worker’s pay in the US as productivity has continued to grow strongly and growth in average compensation has slowed substantially. This column explores the causes and implications of this trend. Productivity growth appears to have continued to push workers’ wages up, with other factors to blame for the divergence. The evidence casts doubt on the idea that rapid technological progress is the primary driver here, suggesting rather that institutional and structural factors are to blame.

Stansbury and Summers writes,

Our contribution to these debates is, we believe, to demonstrate that productivity growth still matters substantially for middle income Americans. If productivity accelerates for reasons relating to technology or to policy, the likely impact will be increased pay growth for the typical worker.

We can use our estimates to calculate a rough counterfactual. If the ratio of the mean to median worker's hourly compensation in 2016 had been the same as it was in 1973, and mean compensation remained at its 2016 level, the median worker's pay would have been around 33% higher. If the ratio of labour productivity to mean compensation in 2016 had been the same as it was in 1973 (i.e. the labour share had not fallen), the average and median worker would both have had 4-8% more hourly compensation all else constant. Assuming our estimated relationship between compensation and productivity holds, if productivity growth had been as fast over 1973-2016 as it was over 1949-1973, median and mean compensation would have been around 41% higher in 2016, holding other factors constant.

This suggests that the potential effect of raising productivity growth on the average American’s pay may be as great as the effect of policies to reverse trends in income inequality – and that a continued productivity slowdown should be a major concern for those hoping for increases in real compensation for middle income workers.

This does not mean that policy should ignore questions of redistribution or labour market intervention – the evidence of the past four decades demonstrates that productivity growth alone is not necessarily enough to raise real incomes substantially, particularly in the face of strong downward pressures on pay. However it does mean that policy should not focus on these issues to the exclusion of productivity growth – strategies that focus both on productivity growth and on policies to promote inclusion are likely to have the greatest impact on the living standards of middle-income Americans.

So productivity still matters for pay with increases in productivity increases resulting in pay increases.

Hal Varian interview

Hal Varian is interviewed by James Pethokoukis of the AEI. Varian is, of course, well known by all economics students due to his undergraduate and graduate microeconomics textbooks. Varian is now Google's chief economist. He is professor emeritus at the University of California, Berkeley.

Is the concept of inequality the best way of thinking about our economic problems?

This question is asked by Tyler Cowen in a chapter in a new book The US Labor Market: Questions and Challenges for Public Policy, edited by Michael Strain, which is freely available online from the American Enterprise Institute. The issues raised in the book are relevant to more countries than just the US.

Cowen opens by making an interesting comparison,

I find it useful to compare the productivity slowdown and the increase in income inequality. It seems the productivity slowdown has been of much greater consequence for human welfare, including for lower-income groups. For instance, if American productivity growth had not slowed after 1973, today the median household would earn $30,000 more each year. Alternatively, if income inequality had not accelerated after 1973, today the median household would earn an extra $9,000 more. That is less than one-third of the loss from the productivity slowdown.

One question I would ask is why income inequality and not consumption inequality? Consumption seems more relevant to people's well being.

Cowen goes on to say,

I wish to suggest a simple hypothesis: income inequality (or for that matter wealth inequality) is not the real problem. Rather, the problem is that many Americans are not seeing their lives improve as much as we would like. This is a problem whether or not the top 1 percent is seeing big gains. The problem has to do with the low level of earnings or health or well-being or opportunity for some individuals, not the disparity per se. That is a simple point, but it is difficult to communicate in today’s discourse on these issues, and it turns out to have significant concrete implications for how we should seek remedies.

Later Cowen notes,

Practically speaking, that conceptual mistake misdirects the focus to making people or their outcomes more alike, rather than elevating opportunity for those at the bottom and also in the middle. In fact, opening up enterprise and opportunity for large numbers of people often increases measured income inequality, even when it makes life better for most people, including those at the bottom. Let’s say for instance that global markets were opened up to additional trade, or occupational licensure were relaxed and new commercial opportunities were created. Some people could use these new opportunities to earn much more than others, perhaps millions or even billions more. Probably most people would be better off, but since measured inequality might well rise, analysts who focus on inequality are likely to overlook or undervalue these potential remedies. Keep in mind that the larger a market economy, the larger a country, and the higher the level of aggregate wealth, the higher the level of inequality is likely to be for purely natural reasons; if everything and everyone is clustered at or near zero, inequality just can’t get very high.

Relevant to my question about consumption inequality Cowen points out that,

If we look at the inequality of consumption, rather than income, and count government benefits as a relevant part of income, it turns out actual inequality is considerably lower than many popular or even academic discussions might indicate.

If global inequality is part of the inequality we are worried about, then we should worry less.

Another striking and under-discussed feature of the inequality debates is that global income inequality has been going down for over 20 years. The very poorest people in the world are now much wealthier than before, and significant portions of China, India, Africa, and other developing parts of the world now belong to a growing global middle class. Several billion people have been lifted out of extreme poverty into better circumstances, and over time we can expect the emerging economies to grow at faster rates than the wealthy ones, which will limit inequality all the more. At the same time, scourges such as malaria, polio, and other diseases have for the most part lost ground, most of all in poorer countries. The last 20 to 30 years are probably the most egalitarian time, in terms of income, the world has ever seen. So to the extent income equality is important, we should be celebrating like never before. More specifically, every discussion of income inequality, if it is to be accurate and scientific, should open by framing its worries in the context of a time that has made unparalleled strides toward limiting income inequality overall. Of course for political reasons that is not a popular presentation, but it is an accurate one.

Cowen then looks at key drivers of the increase in inequality. He shows that it makes sense to disaggregate "the inequality problem," as a lot of it isn’t a problem at all, or again it is a problem of some kind other than an inequality problem.

Take as an example one issue you see much discussed which is skills-biased technical change. And there could be a problem here. It is bad that some individuals do not work well with information technology, which is becoming so much more important to most people's work, and this does harm their wages and future opportunities. But the problem part of that equation is not an inequality problem; it is an education problem and a retraining problem. Cowen also discusses issues to do with global markets and rent-seeking.

Cowen sums up this section by saying,

In sum, America [and likely New Zealand] has serious problems of inadequate education, lack of retraining, and some quite bad policies in particular areas. In most cases that disaggregation is a better way of understanding what is going on rather than emphasizing inequality at the macro-economic level. The gap between rich and poor is neither the major driver of the actual problems nor the most important symptom of the most significant problems. Lack of opportunity in absolute terms is the main symptomatic problem.

In the last section of his chapter Cowen looks at the question, How Should Policy Respond? He briefly discusses five areas, Health Care, Occupational Licensing, Education Cheaper Rent and Lower Home Prices, Discontinue or Ameliorate the War on Drugs and End Crony Capitalism.

With regard to house prices and rents, an issue New Zealanders can relate to, Cowen writes,

These days it is harder for Americans to migrate successfully to some of the most economically dynamic American cities, in large part because of high rents and restrictive building codes, stemming from the NIMBY mentality. For a low-skilled worker, the higher wages in New York or San Francisco do not always make up for the much higher rental costs. In the 1950s, a typical apartment in New York City rented for about $60 a month, or adjusting for inflation about $530 a month; today that is closer to the cost of a parking space in Manhattan. If it were cheaper to move into major American cities, more Americans would have an easier path toward a higher salary and a brighter future. Economists Chang-Tai Hsieh and Enrico Moretti have argued that the American economy could become much richer if more workers could move from the low-productivity cities to the high-productivity cities; that would increase income mobility, too. Hsieh and Moretti estimate that lower rents, through building deregulation, could increase American GDP by almost 10 percent. A lot of those gains would go to Americans who cannot currently afford to move to San Francisco and other high-productivity cities.

The size of the effect on GDP of having people move from low-productivity areas to high-productivity areas did come as a surprise to me.

Cowen ends by saying that the United States has some very real and obvious problems, many of which impact the low- and middle-income earners of America in particular, but the concept of inequality is not the best conceptual starting point for finding or evaluating potential solutions.

There are many other interesting points made in Cowen's chapter and it is well worth the read, no matter what your current view of inequality.

The book containing Cowen's chapter also has many other useful chapters on a variety of issues to do with labour markets. Anyone interested in such markets should give it a read.

Resource misallocation & productive growth

Chang-Tai Hsieh, IGC steering group member, explains why some firms are more successful than others, using Indian firms as a case study. The Indian example shows that entrepreneurs can find ways around inefficient regulation. The problem of course is that the workaround is not fully efficient, a better policy would be to remove the bad regulation in the first place. But as noted by Hsieh politicians aren't willing to go there. Another example of bad politics driving out good economics.

Business owners, employees and firm performance

Business Owners, Employees and Firm Performance is a new working paper, by Mika Maliranta and Satu Nurmi, from the Research Institute of the Finnish Economy (ETLA).

The abstract reads:

The novel Finnish Longitudinal OWNer-Employer-Employee (FLOWN) database was used to analyze how the characteristics of owners and employees relate to firm performance as determined by labor productivity, survival and employment growth. Focusing on the role of the owner’s formal education and previous experience as an employee, the results show that previous experience in a high-productivity firm strongly predicts high productivity and probability of survival for the entrepreneur’s new firm. This can be interpreted as evidence of knowledge spillover through labor mobility. Strikingly, firms established in times of intensive excess job reallocation were found to exhibit superior productivity performance in the later phases of their life cycles.

The conclusion to the paper includes,

The diversified paths of primary owners and their employees are reflected in future company performance. Previous employer quality, measured in terms of relative productivity, is transferred through owners and employees as knowledge spillover related, for example, to technology or management. High-quality owners create firms capable of achieving and maintaining sustained high performance in terms of productivity, survival and employment growth.

Our results lend support to the view that employees’ entrepreneurial skills nurtured in high-productivity firms can be transferred to achieve higher productivity, especially in entrepreneur-owner firms. First, there is a strong positive relationship between the productivity level of the previous firm (where the owner worked as an employee) and the productivity level of the firm where the owner now works. Second, there is evidence of considerable employee mobility from high-productivity firms to ownership of a new firm (where the owner also works). These findings are consistent with the view that the transition of employees from high-productivity firms to entrepreneurship is an important business dynamic, driving knowledge spillover in the economy. Our results also indicate intensive employee mobility from low-productivity firms toward new and young firms, representing an important element of creative destruction. The reallocation of employees in creative destruction means that a greater share of the employees provide labor inputs to productively managed firms

and

Our results demonstrate the importance of considering owner and employee characteristics separately but in parallel in any analysis of firm performance, as owner and employee background and skills may play different roles in the development of employment and productivity. In addition, this analysis indicates a need to deal separately with entrepreneur-owner and pure owner firms. In entrepreneur-owner firms, an owner’s technically orientated education was found to impact positively on productivity performance and survival probability, but no such relationship was found in pure owner firms. One explanation for this difference is that closer owner links to production are needed to successfully exploit technical education and previous experience. In contrast, the potential contribution of pure owners pertains to factors that cannot be captured by measures of education and experience.

One interpretation of this is the perhaps not too surprising result that the human-capital of an entrepreneur-owner matters for the performance of a newly created firm. Knowledge gained from experience as an employee of a high productivity firm can be transferred to the firm of the entrepreneur-owner. Newer firms have relatively younger and more educated human capital but are more dependent on the older firms for an inflow of know-how.

How much does management matter?

Can productivity gaps be explained by differences in management? In this short video, from VoxEU.org, Raffaella Sadun presents her research in management and the differences between being a micro-manager and a coordinator.

In short. micro-management can be bad for you.

Managers and productivity differences

Productivity, and the reasons why some countries are more productive than others is an issue of long-standing interest to economists. Cross-country differences in productivity are pondered over and worried about in the policy circles of most countries, including New Zealand. A new column at VoxEU.og, by Nezih Guner, Andrii Parkhomenko and Gustavo Ventura, attempts to dig a little deeper in to the issue, looking into differing managerial quality between different nations. In high-income countries, the mean earnings of managers tend to grow faster than for non-managers and the earnings growth of managers relative to non-managers corresponds to output per worker. To understand why countries like Italy (and New Zealand?) lag behind the US in terms of output per worker, they argue we should take into account that there are more incentives to invest in managerial skills in the US.

The modelling approach taken in the column is described as

In order to understand and draw implications from our empirical findings, we study a span-of-control model with a life-cycle structure. Every period, a large number of finitely lived agents are born. These agents are heterogeneous in terms of their initial endowment of managerial skills. The objective of each agent is to maximise the lifetime utility from consumption. In the first period of their lives, agents make an irreversible decision to be either workers or managers. In the model economy, differences in managerial quality emerge from differences in selection into management work, along the lines of Lucas (1978), and differences in skill investments, as we allow for managerial abilities to change over time as managers invest in their skills. Hence, we place incentives of managers to invest in their skills and the resulting endogenous skill distribution of managers at the centre of income and productivity differences across countries.

In the model economy, skill investment decisions reflect the costs (resources that have to be invested rather than being consumed) and the benefits (the future rewards associated with being endowed with better managerial skills). Since consumption goods are an input for skill investments, a lower level of aggregate productivity results in lower incentives for managers to invest in their skills. Furthermore, managers face potential size-dependent distortions as in the literature on misallocation in economic development. We model size-dependent distortions as progressive taxes on the output of a plant, and do so via a simple parametric function that was proposed originally by Benabou (2002).

Size-dependent distortions have two effects in our setup.

• First, a standard reallocation effect, as the introduction of distortions implies that capital and labour services flow from distorted (large) to undistorted (small) production units;
• Second, a skill accumulation effect, as distortions affect the incentives for skill accumulation and thus, the overall distribution of managerial skills – which manifests itself in the distribution of plant level productivity.

Overall, under higher exogenous productivity and smaller distortions, managers invest more in their skills in equilibrium and operate larger and more productive plants. As a result, both output per worker and the gap between the earnings of managers to non-managers become larger, in line with the cross-country evidence presented in Figure 1

Figure 1. Cross-country relationship between output per worker and lifetime growth of managers’ earnings relative to non-managers

Guner, Parkhomenko and Ventura conclude,

[...] we contend that in order to understand why countries like Italy and others lag behind the US in terms of output per worker, we should take into account that in the US, the incentives to invest in managerial skills are not as distorted. A young person who contemplates a managerial career takes into account distortions (regulations and other factors that act as implicit size-dependent taxes) that he or she will face when earning a higher compensation as a manager. In economies with larger distortions, individuals will either invest less in their managerial skills or choose a non-managerial career. In equilibrium, these reactions lead to lower managerial quality and output per worker, and to lower earnings growth of managers relative to non-managers, as the data indicates.

Housing and productivity

Up until now I have never really gotten the reason for people getting so excited about the effects of housing on productivity. When the Productivity Commission looked into the problems with housing in New Zealand it didn't seem to me to be the obvious factor explaining New Zealand's low productivity growth.

Well it turnouts I may have to rethink this issue. The Economist magazine has an article which explains How cheaper housing can boost productivity. They write,

To understand how cheap housing could boost productivity, consider the British economy. Inner London is by far the most productive region of the country, thanks to its clusters of finance, technology and nerds. More than one third of new jobs created in Britain since the recession have been based in the capital. London could create more still, but its lack of housing hems it in. The average house there now costs £370,000 ($577,000), nearly double the national average. Soaring demand has met stagnant supply. In the past decade the number of homes in London has grown by just 8%. The effect of high house prices is to push people out of London (or stop them moving in), and thus put them in less productive jobs. Others waste time on marathon commutes. From 2005 to 2014 the number of people commuting into London rose by 32%. One paper published in 2010 found that absenteeism among German workers would be 15-20% lower if they did not commute. If it were somehow possible to scrap commuting altogether, the British economy would see a productivity boost worth £12 billion a year, according to the Centre for Economics and Business Research, a think-tank.

Now if the effects of cheaper housing on productivity in New Zealand are of this order of magnitude then this is another big reason for doing something about freeing up the supply-side of the housing market. This makes reforming the local government regulation of building new homes or modifying existing ones look all that much more important. This is especially true of Auckland where the returns to reform will be the greatest since it has the greatest "clusters of finance, technology and nerds" in the country.

Competition and productivity

The Competition and Markets Authority (CMA) in the U.K. has produced a report (pdf) which looks at the the theoretical and empirical evidence on the relationship between competition and productivity. The report states that,

The evidence reviewed here addresses two separate but related questions: first, does stronger competition between firms lead to higher levels of productivity; and second, does competition policy and enforcement lead to stronger competition and hence higher productivity?

There is a strong body of empirical evidence showing that competition can drive greater productivity. Within-country studies demonstrate a positive relationship between strength of competition and productivity growth across sectors. Similarly, cross-country studies suggest that countries with lower levels of product market regulation, enabling stronger competition, tend to have higher levels of productivity growth.

There is also an extensive literature examining the impact on productivity of changes in competition over time, including as a result of deregulation. These studies show generally strong positive effects on productivity in sectors where deregulation has occurred, including transport and utilities.

There are three main mechanisms via which competition drives productivity. First, within individual firms managers are forced to become more efficient when facing competition from other firms. Secondly, competition means that the more productive firms increase their market share at the expense of those firms that are less efficient. The low productivity firms may, in the end, be forced out of the market having been replaced by more productive firms. Thirdly, and perhaps most importantly, competition drives firms to innovate, coming up with new products and processes which can lead to step-changes in efficiency.

These ideas kinda seems obvious when you see them but they are often forgotten when people talk about the advantages of deregulation and increased competition in markets.

So it's all endogenous

There has been much comment around the traps about a study that claims that ageing populations  hinder economic growth.The study predicts the effect of demographic change on growth rates in the current decade and shows that an ageing population will knock over a percentage point off growth rates for some countries, including New Zealand - see the graphic below.


But now James Zuccollo at the TVHE blog points out that the effect may be endogenous. Zuccollo writes,

In a ray of light, this morning’s FT (£) reported a study of over 15,000 German employees that examined the relationship between ageing and productivity. One of the authors is quoted saying:

As workforces age, employers are concerned that productivity will decrease. That is not so. What matters is not chronological age but subjective age.

The research suggests that older people are systematically excluded from training activities, and are relegated to less creative and meaningful work, which renders them less productive. As the workforce ages, that may begin to change. As it changes, the relationship between growth and age structures is likely to weaken.

Getting cause and effect right is important. This highlights why when thinking about topics like productivity you need to think at the firm level. How firms react to changes in the demographics of their workforce will help determine the rate of productivity growth. Just looking at aggregate data can obscure such effects.

Management and productivity: An interview with Nicholas Bloom

The following comes from an interview with Stanford University economist Nicholas Bloom available online at "Econ Focus", the economics magazine of the Federal Reserve Bank of Richmond.

EF: Another branch of your research has focused on how management practices affect firm and country productivity. Why do you think management practices are so important?

Bloom: My personal interest was formed by working at McKinsey, the management consulting firm. I was there for about a year and a half, working in the London office for industrial and retail clients.

There's also a lot of suggestive evidence that management matters. For example, Lucia Foster, John Haltiwanger, and Chad Syverson found using census data that there are enormous differences in performance across firms, even within very narrow industry classifications. In the United Kingdom years ago, there was this line of biscuit factories — cookie factories, to Americans — that were owned by the same company in different countries. Their productivity variation was enormous, with these differences being attributed to variations in management. If you look at key macro papers like Robert Lucas' 1978 "span of control" model or Marc Melitz's 2003 Econometrica paper, they also talk about productivity differences, often linking this with management.

Economists have, in fact, long argued that management matters. Francis Walker, a founder and the first president of the American Economic Association, ran the 1870 U.S. census and then wrote an article in the first year of the Quarterly Journal of Economics, "The Source of Business Profits." He argued that management was the biggest driver of the huge differences in business performance that he observed across literally thousands of firms.

Almost 150 years later, work looking at manufacturing plants shows a massive variation in business performance; the 90th percentile plant now has twice the total factor productivity of the 10th percentile plant. Similarly, there are massive spreads across countries — for example, U.S. productivity is about five times that of India.

Despite the early attention on management by Francis Walker, the topic dropped down a bit in economics, I think because "management" became a bad word in the field. Early on I used to joke that when I turned up at seminars people would see the "M-word" in the seminar title and their view of my IQ was instantly minus 20. Then they'd hear the British accent, and I'd get 15 back. People thought management was quack doctor research — all pulp-fiction business books sold in airports.

Management matters, obviously, for economic growth — if we could rapidly improve management practices, we would quickly end the current growth slowdown. It also matters for public services. For example, schools that regularly evaluate their teachers, provide feedback on best practices, and use data to spot and help struggling students have dramatically better educational outcomes. Likewise, hospitals that evaluate nurses and doctors to provide feedback and training, address struggling employees, and reward high performers provide dramatically better patient care. I teach my Stanford students a case study from Virginia Mason, the famous Seattle hospital that put in place a huge lean-management overhaul and saw a dramatic improvement in health care outcomes, including lower mortality rates. So if I get sick, I definitely want to be treated at a well-managed hospital.

EF: How much of the productivity differences that you just discussed are driven by management?

Bloom: Research from the World Management Survey that Raffaella Sadun, John Van Reenen, and I developed suggests that management accounts for about 25 percent of the productivity differences between firms in the United States. This is a huge number; to give you a benchmark, IT or R&D appears to account for maybe 10 percent to 20 percent of the productivity spread based on firm and census data. So management seems more important even than technology or innovation for explaining variations in firm performance.

Coincidentally, you do the same exercise across countries and it's also about 25 percent. The share is actually higher between the United States and Europe, where it's more like a third, and it's lower between the United States and developed countries, where it's more like 10 to 15 percent.

Now, you may not be surprised to learn that there are significant productivity differences between India and the United States. But you look at somewhere like the United Kingdom, and it's amazing: Its productivity is about 75 percent of America's. The United Kingdom is a very similar country in terms of education, competition levels, and many other things. So what causes the gap? It is a real struggle to explain what it is beyond, frankly, management.

EF: What can policy do to improve management practices?

Bloom: I think policy matters a lot. We highlight five policies. One is competition. I think the key driver of America's management leadership has been its big, open, and competitive markets. If Sam Walton had been based in Italy or in India, he would have five stores by now, probably called "Sam Walton's Family Market." Each one would have been managed by one of his sons or sons-in-law. Whereas in America, Walmart now has thousands of stores, run by professional nonfamily managers. This expansion of Walmart has improved retail productivity across the country. Competition generates a lot of diversity through rapid entry and exit, and the winners get big very fast, so best practices spread rapidly in competitive, well-functioning markets.

The second policy factor is rule of law, which allows well-managed firms to expand. Having visited India for the work with Benn Eifert, Aprajit Mahajan, David McKenzie, and John Roberts, I can say this: The absence of rule of law is a killer for good management. If you take a case to court in India, it takes 10 to 15 years to come to fruition. In most developing countries, the legal system is weak; it is hard to successfully prosecute employees who steal from you or customers who do not pay their invoices, leading firms to use family members as managers and supply only narrow groups of trusted customers. This makes it very hard to be well managed — if most firms have the son or grandson of the founder running the firm, working with the same customers as 20 years ago, then it shouldn't be surprising that productivity is low. These firms know that their sons are often not the best manager, but at least they will not rampantly steal from the firms.

The third policy factor is education, which is strongly correlated with management practices. Educated and numerate employees seem to more rapidly and effectively adopt efficient management practices.

The fourth policy factor is foreign direct investment, as multinational firms help to spread management best practices around the world. Multinational firms are typically incredibly well run, and that spills over. It's even true in America, where its car industry has benefited tremendously from Honda, Toyota, Mitsubishi, and Volkswagen. When these foreign car manufacturers first came to America, they achieved far higher levels of productivity than domestic U.S. firms, which forced the American car manufacturers to improve to survive.

The fifth factor is labor regulation, which allows firms to adopt strong management practices unimpeded by government. In places like France, you can’t fire underperformers, and as a result, it's very hard to enforce proper management.

EF: Do you expect America's productivity advantage to continue?

Bloom: On the above five criteria, the United States scores an "A" on four of them except education, where we score a "C." The United States has a weak school system and poor education standards compared to a number of our competitors. For example, based on OECD Pisa [Programme for International Student Assessment] scores, the U.S. educational system ranks in the mid-20s on math, below many European and East Asian countries. So improving educational standards is the most obvious way to improve management and ultimately growth, because poor education makes it harder to manage our firms. Fixing U.S. education will take more funding. But most importantly, it will require dismantling the cobweb of restrictions that teachers unions and politicians have put on schools, like tenure and seniority-based pay.

If you fix these five drivers of management, you're 95 percent of the way there. Most other factors seem of secondary importance compared to the big five of competition, rule of law, education, foreign direct investment, and regulations.

EF: Management practices can be viewed as "soft" technologies, compared to so-called "hard" technologies such as information technology. Do you see anything special about the invention and adoption of these "soft" technologies relative to "hard" technologies?

Bloom: The only distinction is that hard technologies, like my Apple iPhone, are protected by patents, whereas process innovations are protected by secrecy.

The late Zvi Griliches, a famous Harvard economist, broke it down into two groups: process and product innovations. Most people who think of innovation think of product innovations like the shiny new iPhone or new drugs. But actually a lot of it is process innovations, which are largely management practices.

Good examples would be Frederick Winslow Taylor and scientific management 100 years ago, or Alfred Sloan, who turned a struggling General Motors into the world's biggest company. Sloan pushed power and decision-making down to lower-level individuals and gave them incentives — called the M-form firm. It seems perfectly standard now, but back then firms were very hierarchical, almost Soviet-style. And then there was modern human resources from the 1960s onward — the idea that you want to measure people, promote them, and give them rewards. Most recently, we have had "lean manufacturing," pioneered by Toyota from the 1990s onward, which is now spreading to health care and retail. This focused on data collection and continuous improvement.

These have been major milestones in management technologies, and they've changed the way people have thought. They were clearly identified innovations, and I don't think there's a single patent among them. These management innovations are a big deal, and they spread right across the economy.

In fact, there's a management technology frontier that's continuously moving forward, and the United States is pretty much at the front with firms like Walmart, GE, McDonald's, and Starbucks. And then behind the frontier there are a bunch of laggards with inferior management practices. In America, these are typically smaller, family-run firms.

EF: What are the key challenges for future research on management?

Bloom: One challenge is measurement. We want to improve our measurement of management, which is narrow and noisy.

The second challenge is identification and quantification: finding out what causes what and its magnitude. For example, can we quantify the causal impact of better rule of law on management? I get asked by institutions like the World Bank and national governments which policies have the most impact on management practices and what size impact this would be? All I can do is give the five-factor list I've relayed here; it's very hard to give any ordering, and there are definitely no dollar signs on them. I would love to be able to say that spending $100 million on a modern court system will deliver $X million in extra output per year.

One way to get around this — the way macroeconomists got around it — is to gather great data going back 50 years and then exploit random shocks to isolate causation. This is what we are trying to do with the World Management Survey. The other way is a bit more deliberate: to run field experiments by talking with specific firms across countries.

In the New Zealand context its interesting to note Bloom's comments on the effects of foreign direct investment. Multinational firms help improve the standard of management in the host country and thus help improve productivity. Add this to the point that Eric Crampton noted about foreign firms paying their employees more, then foreign investment in New Zealand looks better than the anti-FDI crowd would have us believe. Also Bloom highlights the advantages of a flexible labout market. Given the small size of the internal New Zealand market Bloom's point about the importance of competition to good management practices emphasises the  need to keep New Zealand open to trade so that local produces face as much competition as possible from foreign firms.

A research agenda on NZ's productivity

One of the most discussed issues to do with the New Zealand economy is New Zealand's less than stellar history of productivity growth. We do OK for a couple of years every now and then, but we can't keep it up. Trying to explain this history is a complex and difficult task but one which the "Productivity Hub" - a part of Government Economic Network - was set up to help coordinate.

Patrick Nolan has a paper in Policy Quarterly - vol. 10 no. 2 May 2014 - outlining the development by the Productivity Hub of a "Forward Looking Agenda of Research" or FLARE. Yes you do have to wonder if they couldn't have come up with a better name.

Nolan writes,

The objective of FLARE is to provide a list of relevant research projects which would advance understanding of New Zealand's productivity issues and ultimately improve policy. A short-list of proposed projects for the next two years is shown in Figure 2.

Figure 2 is

One thing with regard to point 1 in Figure 2 is that the theory of firm-level productivity isn't based on the theory of the firm. It is based on the theory of production - think what you were taught about production in 2nd year micro, for a book length discussion see Rasmussen (2013). For a survey of the contemporary theory of the firm see Walker (forthcoming). The theories are very different and are useful for examining different aspects of the productivity puzzle. This bring me to a related point that Nolan makes,

Although these are largely descriptive questions, they are nonetheless important, as clearly identifying what you are dealing with is a useful starting point for analysis. Further, this descriptive analysis will provide a basis for an improved understanding of how changes take place at the level of the firm.

To fully understand such changes requires recourse to the boarder area of organisational economics (see Gibbons and Roberts 2013) rather than just an emphasis on the theory of the firm or on production economics. Looking in side the firm to see how changes in management, in corporate culture, incentives within the firm, internal labour markets etc alter productivity seems important.

Nolan goes on to say,

As Sautet (2000) noted, many currently accepted theories of the firm cannot provide insights into important market phenomena such as entrepreneurship.

While there is truth to Sautet's comment, this is an area in which progress is being made. Two recent examples are Spulber (2009) and Foss and Klein (2012) - for a quick summary of these works see sections 3.2 and 3.3 of Walker (forthcoming).

Nolan also notes, correctly, the importance of understand the data utilised in empirical studies.

This approach should also help to contribute to efforts to improve measures of productivity and understanding of their limits, including the differences between firm-based and economy-wide (macro) measures.

This point about difference in micro and macro measure highlighted by the debate over the so-called "Solow Paradox"- Robert Solow famously quipped in a 1987 review of the book “Manufacturing Matters: The Myth of the Post-Industrial Economy” that: “[y]ou can see the computer everywhere but in the productivity statistics”, a remark that has given rise to what is often called the “Solow productivity paradox”. It turns out that the paradox is a paradox only at the macro data level, micro-level data provides little evidence in support of Solow’s paradox. Pilat (2004: 11) explains “[s]tudies with firm-level data often find the strongest evidence for economic impacts of ICT.” Recent research on the productivity paradox based on firm-level data suggests that ICT use is beneficial to firm performance and productivity, even for industries and countries where there is no evidence at the more aggregate levels. This result holds for all countries in which micro-level studies have been carried out. For example, studies have found that ICT capital deepening increased labour productivity in services firms in Germany and the Netherlands. A close correlation between labour productivity and ICT use was found for Swiss firms. Another study looked at ICT use in Finland and concluded there are productivity-enhancing effects associated with ICTs. Yet more work found that greater use of ICTs was associated with higher labour productivity growth in the nineties for Canada. Another paper analysed U.K. data and found a positive effect on labour productivity and multi-factor productivity associated with the exploration of computer networks for trading. U.S. data was used to demonstrate that average labour productivity was higher in plants with computer networks with labour productivity being around 5 percent higher for such plants.

Serious thinking about the data used in empirical studies is not given enough emphasis.

There are  many other interesting and important issues raised in  Nolan's paper which if you are interested in New Zealand's productivity performance is well worth reading.

Refs.:

• Foss, Nicolai J. and Peter G. Klein (2012). Organizing Entrepreneurial Judgment: A New Approach to the Firm. Cambridge: Cambridge University Press.
• Gibbons, Robert and John Roberts (2013). The Handbook of Organizational Economics, Princeton: Princeton University Press.
• Pilat, Dirk (2004). ‘Introduction and Summary’. In OECD, The Economic Impact of ICT − Measurement, Evidence and Implications, Paris: Organisation for Economic Cooperation and Development.
• Rasmussen, Svend (2013). Production economics: The Basic Theory of Production Optimisation, Berlin: Springer-Verlag.
• Spulber, Daniel F. (2009). The Theory of the Firm: Microeconomics with Endogenous Entrepreneurs, Firms, Markets, and Organizations. Cambridge: Cambridge University Press.
• Walker, Paul (forthcoming). "Contracts, Entrepreneurs, Market Creation and Judgement: The Contemporary Mainstream Theory of the Firm in Perspective". Journal of Economic Surveys.

Innovation, exports and technical efficiency

What are the effects of the size of the market in which a firm operates on the efficiency and productivity of the firm? According to a new working paper by M. Ángeles Díaz-Mayans and Rosario Sánchez-Pérez those Spanish firms involved in exporting, and thus facing a market much larger than just the local market, are more efficient and productive.

The abstract of the paper reads,

This paper analyses the relationship between exports, innovative activities and size and their effect over firms’ technical efficiency and then over their productivity. The analysis takes, also, into account other variables that could affect productivity as industrial sector, or firms’ financial conditions. We use a micro panel data set of Spanish manufacturing firms, during the period 2004–2009, to simultaneously estimate a stochastic frontier production function and the inefficiency determinants. The data source is published in the Spanish Industrial Survey on Business Strategies (Encuesta sobre Estrategias Empresariales, ESEE), collected by Fundación SEPI. Our results show that exporting firms are more efficient than non-exporting firms; and that small and medium-sized firms’ tent to be more efficient when they focus on international markets.

An obvious question this gives raise to is, Why? From the conclusion of the paper,

The inefficiency determinants can be due to environmental or firm specific factors. Here we focus on these firms specific factors to provide an explanation to the differences in technical inefficiency across Spanish manufacturing firms. Inefficiency tends to be smaller for firms with a higher ratio of gross investment over capital. Firms that account for this kind of investment become more competitive as a consequence of having a higher efficiency in their production process.

Also, we found that exporting firms are closer to the stochastic frontier. They have to be more competitive to sell in international markets. Only the most efficient firms survive in the highly competitive international market.

Size is another determinant of technical efficiency. Even though the impact of size in technical efficiency is not clearly determined in empirical and theoretical frameworks, here we obtain a positive and significant effect over efficiency. What it means that large firms are closer to the efficient frontier.

In addition, efficiency tends to be smaller for those firms with a higher proportion of external funds over value added.

None of these results seem counter-intuitive but you may ask about causation in some cases. For example does size help determine efficiency or does efficiency help determine size? That is, it is the more efficient firms that grow?

Anyway, more reasons for supporting free trade.

Competition and productivity

An obvious and important question in industrial economics is does competition raise productivity and if so, through what mechanism? In a 2010 working paper, Does Competition Raise Productivity Through Improving Management Quality?, John Van Reenen sets out to answer that question. He writes,

I discuss recent empirical evidence from both large-scale databases and specific industries which suggests that tougher competition does indeed raise productivity and one of the main mechanisms is through improving management practices. To establish this, I report on new research seeking to quantify management. I relate this to theoretical perspectives on the economics of competition and management, arguing that management should be seen at least in part as a transferable technology. A range of recent econometric studies suggest that (i) competition increases management quality and (ii) improved management quality boosts productivity.

Thus Van Reenen's argument is that competition does indeed increase productivity and a major mechanism for this is via improved management practices. He says that management is a transferable technology and that competition fosters the adoption of better management practices through both selecting out the badly managed firms (reallocation) and giving incumbent firms stronger incentives to improve their management practices. He argues that this perspective is supported by a range of new evidence both from new ways of measuring management and from more robust forms of identifying the causal impact of competition changes on productivity outcomes.

This has important implications for a small trading country like New Zealand. Given our small internal market how do we increase competition? One way is to open our markets to foreign trade and investors. Yes, allow foreigners to trade here and to buy assets here. Yes I know, certain political parties will not be too pleased with this idea.

Allowing foreign companies to trade here increases competition in our market in general and thus forces improvement in terms of management on local firms. But as my previous posting on the example of France showed foreign ownership can also improve a firm's productivity. Foreign investors are more likely to takeover firms that are currently under-performing and thus are open to productivity improvements. Such investors are more likely to buy firms that aren't working, right now, as well as they have in the past. The targets of foreign buyouts normally had experienced substantial productivity decline in the years prior to the foreign takeover. The foreign buyers then use their expertise, including improved management practices, to correct things and thus increase productivity. Of course this performance improvement puts additional pressure on other firms to up their game as well.

Thus foreign trade and ownership can both improve productivity by increasing competition in the local market and thus putting pressure on local firms to improve the quality of their management.

Are foreign takeovers getting domestic cherries or lemons?

The concerns of economic nationalists - read NZ First, the Conservatives, Labour etc in the case of New Zealand - about foreign takeovers of assets, including land, are rooted in the idea that foreign enterprises extract the most valuable assets from top performing domestic firms. This argument puts to one-side for now the ever present xenophobia which underlies much of the anti-foreign investment rhetoric in New Zealand. Practical concerns about economic efficiency of cross-border mergers and acquisitions markets hinge on whether takeovers transfer underperforming domestic economic resources toward more productive uses at foreign enterprises. How then to reconcile these concerns when forming policies about cross-border activity? Well in a new column at VoxEU.org Farid Toubal , Bruce Blonigen, Lionel Fontagné and Nicholas Sly argue it’s all in the timing.

One of the big questions about foreign investment is are the foreign firms picking cherries or choosing lemons?

For many years the evidence about targets of foreign acquisitions has been mixed. Some theories and data suggest that ‘lemons’ – domestic firms with relatively weak performance – are the most likely targets of foreign acquisition. Yet more recent empirical studies have pointed to ‘cherries’ as the most likely targets for takeover by foreign firms. The disagreement about which type of domestic firms – cherries or lemons – are pursued by foreign enterprises made it difficult to answer policy makers’ question about which of their assets, economic networks, and production possibilities were suddenly in the hands of foreign ownership.

The doubt over which types of firms were being acquired also raises concerns about the efficiency of international merger and acquisition (M&A) markets. Ideally, market transactions should transfer resources toward their most efficient use. The same holds for M&A markets, which should transfer the assets of lesser performing firms to enterprises that can make better use of them. If domestic firms are high performing cherries, it is not evident that a transfer of ownership of their resources to a foreign enterprise is optimal; being a cherry implies that a domestic firm is already using its resources effectively. Poor performing lemons might seem to fit the bill. Yet the question remains open as to why a foreign enterprise would choose to enter a market using resources that even a domestic firm – which had more familiarity with resident consumers, regulations, and distribution networks – could not use profitably.

Blonigen, Fontagne, Sly, and Toubal argue its all in the timing.

In Blonigen, Fontagne, Sly, and Toubal (2014), we show that the conundrum over whether domestic cherries or lemons are targets of acquisition can be resolved by considering not only the types of assets that foreign acquirers seek, but also the timing of takeovers. Indeed, foreign firms seek domestic targets that are historically high performing. In fact, when we look at foreign acquisitions that occur in the French manufacturing sector over the last decade, we find that even the least productive domestic target outperforms the typical firm in its sector in the years prior to acquisition. See Figure 1 below, which takes advantage of detailed administrative data from France to illustrate systematic changes in firm characteristics as they transition from domestic to multinational status. We plot total factor productivity (TFP) for all manufacturing firms that are acquired by foreign owners between 1999 and 2006 relative to sector and year averages, from three years prior to the acquisition to four years after the firm is acquired. The middle line shows the relative detrended TFP for the average French firm acquired by a foreign owner, whereas the lines above and below show the relative detrended TFP for the 95th and 5th percentiles, respectively. In the years prior to acquisition, domestic targets of foreign acquisition do appear to be ‘cherries.’ They have all a TFP that is above industry-year average.

Figure 1.

Yet despite the high performance of target firms observed several years prior to acquisition, Figure 1 shows that, prior to acquisition, targets realize significant productivity losses relative to other firms in their sector. The losses in productivity are so severe that by the time they are acquired, targets of foreign acquisition no longer appear to be cherries; on average they are indistinguishable from the typical firm from their sector. Put differently, in the years leading up to acquisition domestic targets are underperforming relative other firms in their industry. In these years, targets do look like ‘lemons.’

Rather than targets of foreign acquisition being characterized purely as top performers or underperformers in the market place, foreign enterprises seek out domestic firms that were previously the stars of their industries but then suffered a recent series of negative shocks. Hence, the targets of foreign takeovers are ‘Cherries for Sale.’

This timing of cross-border acquisition activity is quite intuitive. Foreign enterprises seek out targets that have the best and most valuable assets. And not surprisingly, it is the most productive target firms that had the largest incentives to invest in developing such assets. However, foreign enterprises can only offer viable takeover bids once the domestic firm has suffered a turn in fate, and is underutilizing it valuable assets. In this case it is better for the domestic firm to sell its assets to a foreign acquirer that can make better use of them.

So what is the upshot of all of this?

This timing of takeover activity implies that policy makers should have fewer concerns about relinquishing national ownership of its domestic enterprises, as the ‘Cherries for Sale’ are no longer the best and most valuable economic agents within their economic sectors. The observed timing of takeover activity also suggests the efficiency of cross-border M&A markets. Cross-border acquisitions appear to transfer productive assets, technologies, and distribution networks toward enterprises that can make better use of these valuable resources.

So foreign ownership may be good for you after all. The assets being bought by the foreign companies are those not preforming well under their current owners and the foreign owners can make better use of those assets. This is a gain for the local economy.

Ref.:

• Blonigen, B A, L Fontagne, N Sly, and F Toubal, “Cherries for Sale: The Incidence and Timing of Cross-Border M&A”, Journal of International Economics, 2014, forthcoming.

Economists and firms

A few days back Donal Curtin posted a piece at the Economics New Zealand blog on raising productivity in the services sector. A one point he writes,

Maybe economists aren't the best people to investigate business management - with exceptions (eg Baumol, Varian), economists tend to see the business production function as a "black box" with inputs in and outputs out, and they don't typically take the lid off the box - but this looks to me like one of the more likely keys to fit the productivity paradox lock.

I have to say that, in the past at least, he has a point. Economists for many years simply didn't see the workings of the firm as an area they should be bothered with. Arthur Pigou (he of the tax) famously once wrote:

“[ ...] it is not the business of economists to teach woollen manufacturers to make and sell wool, or brewers how to make and sell beer, or any other business men how to do their job. If that was what we were out for, we should, I imagine, immediately quit our desks and get somebody - doubtless at a heavy premium, for we should be thoroughly inefficient - to take us into his woollen mill or his brewery”

While Lord Robbins thought that

“[t]he technical arts of production are simply to be grouped among the given factors influencing the relative scarcity of different economic goods. The technique of cotton manufacture [ ...] is no part of the subject-matter of Economics [ ...]”

As to why the firm was ignored in Austrian economics Witt writes,

“[t]he neglect of the firm as the organizational form of an entrepreneurial venture has a tradition in Austrian economics. It may be traced back to a characteristic of the scientific community in the German language countries. There, economic theory (Volkswirtschaftslehre) and business economics (Betriebswirtschaftslehre) were institutionally segregated as early as at the turn of the century to a degree still unknown today in the Anglo Saxon world. As Lachmann once conjectured, Austrian writers therefore considered the organizational form of entrepreneurial activities to be a topic best left to their business economics fellows”

And if one looks at the history of economic one finds little, if any, interest in the firm. When reviewing the contribution of the old institutionalists to the theory of the firm Hodgson writes,

“[ ...] we search in vain for a well-defined ‘theory of the firm’ within the old institutional economics”.

With reference to the German historical school Le Texier explains

“[m]embers of the German historical school such as Gustav von Schmoller analysed at length the birth and growth of the business enterprise, but they were more historians than economists. None of these thinkers proposed a theory of the business firm”

About the work of Joseph Schumpeter, Hanappi says

“[a] well-defined theory of the firm thus cannot be found in Schumpeter’s oeuvres”.

As to Austrian economics Per Bylund writes,

“[b]ut despite the focus in Austrian economics on [ ...] “mundane economics,” and the fact that “the Austrians [have] so many necessary ingredients for a theory of the firm” [ ...], there is no Austrian theory of the firm”

and

“[w]hereas the theory of the firm has been a neglected area of study in mainstream economics, it has been missing from the Austrian economics literature”.

In the mainstream of economics up until around 1970 the standard theory of the firm was the neoclassical theory which as Donal notes treated the firm as a "black box", a production function or production possibilities set, a means of transforming inputs into outputs with no one asking how the transformation took place.

Since the 1970s, however, things have started to improve. During the 1970s work by Oliver Williamson Alchian and Demsetz and Jensen and Meckling started an upswing in interest in the firm as an significant economic institution. Today one only has to consider works like the "Handbook of Organizational  Economics", edited by Robert Gibbons and John Roberts, Princeton: Princeton University Press, 2013, to see that the firms and their inner workings are taken much more seriously. There are 1200 pages of people at least trying to take the lid off the "black box".

So I would suggest that there are good reason for letting economists, among others, investigate business management.

Given the concern with productivity of firms an additional area of investigation would be the relationship between firms and entrepreneurs. It is, after all, entrepreneurs who innovate and force change in business practises as well as in production techniques of goods and services. One only has to think of the effects of 'just in time' manufacturing to see how organisational change can affect costs and productivity.

The relationship between the theory of the firm and the theory of entrepreneurship is not as yet well understood but process is being made even here as witnessed by the Foss and Klein book "Organizing Entrepreneurial Judgement: A New Approach to the Firm", Cambridge: Cambridge University Press, 2012 (see this previous post) or Daniel Spulber's book "The Theory of the Firm: Microeconomics with Endogenous Entrepreneurs, Markets, and Organizations" , Cambridge: Cambridge university Press, 2009.

Wages and productivity

The relationship between productivity and wages has come alive on Twitter. For some strange reason @smalltorquer asked,

Are low wages a possible cause of NZ's poor productivity @NZprocom? http://t.co/xgrRlUZFdY
— John Small (@smalltorquer) February 17, 2014

But the New Zealand Productivity Commission noted:

@TVHE @smalltorquer Causality always difficult to unpick, but low wages more likely due to low productivity...
— NZ Productivity Comm (@NZprocom) February 17, 2014

When it comes to wages and productivity even Paul Krugman has managed to realise,

Economic history offers no example of a country that experienced long-term productivity growth without a roughly equal rise in real wages. In the 1950s, when European productivity was typically less than half of U.S. productivity, so were European wages; today average compensation measured in dollars is about the same. As Japan climbed the productivity ladder over the past 30 years, its wages also rose, from 10% to 110% of the U.S. level. South Korea's wages have also risen dramatically over time. ("Does Third World Growth Hurt First World Prosperity?" Harvard Business Review 72 n4, July-August 1994: 113-21.)

and Krugman and Obstfeld have written,

As it happens, the past 40 years offer considerable evidence on what happens to the wages of a country whose productivity gains on that of higher-wage nations. Four decades ago, productivity in Europe was well below U.S. levels in most industries, and Japan lagged even further; since then, productivity levels in the advanced world have converged, although most measures still suggest that the United States retains some edge. More recently, a group of "newly industrializing economies" in Asia has achieved spectacular productivity increases starting from a very low base. Given these dramatic changes in relative productivity, what has happened to relative wages?

The answer is that wages have risen in each country, more or less in line with productivity. Table 2-3 shows data on long-run increases in productivity and real wages in several representative countries. Bearing in mind that there are some slippages in the data (for example, there are a number of technical problems in the way that both productivity and real wages are calculated), the basic picture is one in which converging productivity has produced a convergence in wages, just as the theoretical analysis would predict.

Notice that we do not have good data on South Korean wages over the full sample. However, the United States government has been collecting hourly compensation (wages plus benefits) data for the industrial sector of several newly industrializing countries since the mid 1970s. According to these data, South Korean compensation rose from only 5 percent of the U.S. level in 1975 to 46 percent in 1996. An index of compensation in several newly industrializing Asian economies rose from 8 percent of the U.S. level in 1975 to 32 percent by 1996. In short, the experience to date is that wages always do move more or less in line with productivity. (Paul Krugman and Maurice Obstfeld, "International Economics: Theory and Policy", Prentice Hall.)

Following up this, the information below comes from a paper by Martin Feldstein, Professor of Economics, Harvard University and President and CEO of the National Bureau of Economic Research [he has since retied from the NBER post], given to the American Economic Association on January 5, 2008. The paper is entitled "Did Wages Reflect Growth in Productivity?" Feldstein writes,

The level of productivity doubled in the U.S. nonfarm business sector between 1970 and 2006. Wages, or more accurately total compensation per hour, increased at approximately the same annual rate during that period if nominal compensation is adjusted for inflation in the same way as the nominal output measure that is used to calculate productivity.

More specifically, the doubling of productivity represented a 1.9 percent annual rate of increase. Real compensation per hour rose at 1.7 percent per year when nominal compensation is deflated using the same nonfarm business sector output price index.

In the period since 2000, productivity rose much more rapidly (2.9 percent a year) and compensation per hour rose nearly as fast (2.5 percent a year).

and later he says

The relation between wages and productivity is important because it is a key determinant of the standard of living of the employed population as well as of the distribution of income between labor and capital. If wages rise at the same pace as productivity, labor’s share of national income remains essentially unchanged. This paper presents specific evidence that this has happened: the share of national income going to employees is at approximately the same level now as it was in 1970.

Is technological progress history?

When it comes to technological progress and thus economic growth some of the most important questions being asked include, Has technological progress slowed down? Have we really picked all the low-hanging fruit?

A new column by Joel Mokyr at VoxEU.org argues that technological progress is in fact not a thing of the past. Far from it. There are myriad reasons why the future should bring more technological progress than ever before – perhaps the most important being that technological innovation itself creates questions and problems that need to be fixed through further technological progress. If we rethink how innovation happens, we have every reason to suspect that we ain’t seen nothing yet. Not an answer the likes of Robert J. Gordon will take too well.

Technological progress has been the driver of economic growth for the last two centuries. Some authors, such as Robert Gordon and Tyler Cowen, however, are being to suggest that product and process innovation are running out of steam.

• Robert J Gordon and Tyler Cowen, inter alia, have expressed the view that technological progress is slowing down.
• Jan Vijg has suggested that the industrialised West of the 21st century will resemble the declining Empires of late Rome and Qing China .

Their basic point is that technological dynamism is fizzling out. The low-hanging fruits that have improved our lives so much in the 20th century have all been picked. We should be ready for a more stagnant world in which living standards rise little if at all. Joel Mokyr is having none of this. For him "we ain’t seen nothin’ yet, the best is still to come".

My argument concerns both the supply and the demand sides of innovation. Starting with supply, what is it that accounts for sustained technological progress? The relation between scientific progress and technology is a complex two-way street. For example, 19th-century energy-physics learned more from the steam engine than the other way around.

The historical record makes clear that science depends on technology in that it depends on the instruments and tools that are needed for science to advance. New instruments opened new horizons in what Derek Price called "artificial revelation”, observations through instruments that allow us to see things that would otherwise be invisible.

Examples:

• The Scientific Revolution of the 17th century depended critically on the development of the telescope, the microscope, the barometer, the vacuum pump, and similar contraptions.
• The achromatic-lens microscope developed by Joseph J Lister (father of the famous surgeon) in the 1820s paved the way for the germ theory, the greatest breakthrough in medicine before 1900.

The same was true in physics, for instance:

• The equipment designed by Heinrich Hertz allowed him to detect electromagnetic radiation in the 1880s and Robert Millikan’s ingenious oil-drop apparatus allowed him to measure the electric charge of an electron (1911).

In the twentieth century, the impact of instruments on progress is even more apparent. For example:

• X-ray crystallography, developed in 1912, was crucial forty years later in the discovery of the structure of DNA.

If tools and instruments are a key to further scientific progress, it is hard not to be impressed by the possibilities of the 21st century:

• DNA sequencing machines and cell analysis through flow cytometry (to mention but two) have revolutionised molecular microbiology.
• High-powered computers are helping research in every domain conceivable, from content analysis in novels to the (very hard) problems of turbulence.
• Astronomy, nanochemistry, and genetic engineering are all areas in which progress has been mind-boggling in the past few decades thanks to better tools.

To be sure, there is no automatic mechanism that turns better science into improved technology. But there is one reason to believe that in the near future it will do so better and more efficiently than ever before. The reason is access.

Inventors, engineers, applied chemists, and physicians all need access to best-practice science to answer an infinite list of questions about what can and cannot be done. Search engines were invented in the 18th century through encyclopaedias and compendia that arranged all available knowledge in alphabetical order, making it easy to find. Textbooks had indexes that did the same. Libraries developed cataloguing systems and other techniques that made scientific information findable.

But these search systems have their limitations. One might have feared that the explosion of scientific knowledge in the 20th century could outrun our ability to find what we are looking for. Yet the reverse has happened. The development of searchable databanks of massive sizes has even outrun our ability to generate scientific knowledge. Copying, storing, transmitting, and searching vast amounts of information today is fast, easy, and practically free. We no longer deal with megabytes or gigabytes. Instead terms like petabytes (a million gigabytes) and zettabytes (a million petabytes) are being bandied about. Scientists can now find the tiniest needles in data haystacks as large as Montana in a fraction of a second.
And if science sometimes still proceeds by ‘trying every bottle on the shelf’ – as in some areas it still does – it can search with blinding speed over many more bottles, perhaps even peta-bottles.

This brings us to the Cowen question, Have all the low-hanging fruits been picked?

One answer is that the analogy is flawed. Science builds taller and taller ladders, so we can reach the upper branches, and then the branches above them.

• A less obvious answer is that technological progress is fundamentally a dis-equilibrating process.

Whenever a technological solution is found for some human need, it creates a new problem. As Edward Tenner put it, technology ‘bites back’. The new technique then needs a further ‘technological fix’, but that one in turn creates another problem, and so on. The notion that invention definitely ‘solves’ a human need, allowing us to move to pick the next piece of fruit on the tree is simply misleading.

• Each solution perturbs some other component in the system and sows the seed of more needs; the ‘demand’ for new technology is thus self-sustaining.

The most obvious example for such a dynamic is in our never-ending struggles with insects and harmful bacteria. In those wars, evolutionary mechanisms decree that after most battles we win, the enemy regroups by becoming resistant to whatever poison we throw at them. Drug-resistant bacteria are increasingly common and require novel approaches to new antibiotics. The search for novel antibiotics will resume with tools that Chain and Florey would never have dreamed of – but even such new antibiotics will eventually lead to adaptation.

In agriculture, the advance in fertiliser use has helped avert the Malthusian disasters that various doom-and-gloom authors predicted. But the vast increase in nitrate use following Fritz Haber’s epochal invention of the nitrogen-fixing process before World War I has now led to serious environmental problems in aquifer pollution and algae blooms. Again, technology will provide us with a fix, possibly through genetic engineering in which more plants can fix their own nitrates rather than needing fertiliser or bacteria that convert nitrates into nitrogen at more efficient rates.

Another example is energy: For better or for worse, modern technology has relied heavily on fossil fuels: first coal, then oil, and now increasingly on natural gas. The bite-back here has been planetary in scope: climate change is no longer a prospect, it is a reality. Can new technology stop it? There is no doubt that it can, even if nobody can predict right now what shape that will take, and if collective action difficulties will actually make it realistic.

Yes, but what about the workers?!

The big question here is, If technology replaces workers, what will the role of people become? Many commentators have written about having an idle and vapid humanity in a robotised economy. This is a concern for many. There will be disruption and pain, as there always is with progress, but the new technology will also create new demand for workers, to perform tasks that a new technology creates. It is most plausible that in our future new technology will create new occupations we cannot imagine, let alone envisage, as it has in the past.

Furthermore, the task that 20th-century technology seems to have carried out the easiest is to create activities that fill the ever-growing leisure time that early retirement and shorter work-weeks have created. Technological creativity has responded to the growth of free time: a bewildering choice of programmes on TV, the rise of mass tourism, access at will to virtually every film made and opera written, and a vast pet industry are just some examples. The cockfights and eye-gouging contests with which working classes in the past entertained themselves have been replaced by a gigantic high-tech spectator-sports industrial complex, both local and global.

Mokyr closes with a comment on Keynes and his view of the Economic Possibilities for our Grandchildren

In his brief Economic Possibilities for our Grandchildren (1931) Keynes foresaw much of the future impact of technology. His insights may surprise those who regard him as the prophet of unemployment: “all this [technological change] means in the long run [is] that mankind is solving its economic problem” (italics in original). Contemplating a world in which work itself would become redundant thanks to science and capital (Keynes did not envisage robots, but they would have strengthened his case), he felt that this age of leisure and abundance was frightening people because “we have been trained too long to strive and not to enjoy”.