One of the keys to understanding the very sluggish recovery from the Great Recession of 2008-09 is the slowdown in productivity growth. Total factor productivity — a measurement of how much economic output is produced from a given amount of labor and capital — has almost stopped growing over the last 10 years.
Without increased productivity, our economy can only grow if we add more labor and capital. Rapid growth requires both increased productivity and increased growth in employment and investment in capital.
A new study by Gee Hee Hong, Romain Duval and Yannick Timmer of the IMF offers strong evidence that a big part — perhaps one-third — of this productivity slowdown can be attributed to the inability of a damaged financial sector to support businesses in the rest of the economy.
{mosads}The authors find that firms with a higher proportion of debt coming due during the crisis, along with firms that generally were more indebted, experienced lower productivity growth in the five years after the crisis. In other words, the financial damage had long-lasting effects on the non-financial economy.
The authors look at firms in 15 advanced countries, mainly countries in Europe but also the U.S., Japan and Korea. They found that firms in countries that suffered worse financial crises experienced greater decreases in productivity growth. They suggest that a big part of this persisting weakness has been caused by firms cutting back on “intangible” investment, such as research and development (R&D), worker training and better organization.
These activities, although clearly useful, can easily be postponed. They also do not have the advantage that tangible investment has; tangible investment in buildings or even machines can be used as collateral for loans. That can be a major issue for firms in fragile financial circumstances that are also dealing with a fragile banking and financial system.
The immediate implication of the IMF study is that repairing the damage to the financial system should help revitalize economic growth. It also suggests that both firms and governments might look at ways to promote investment in intangible assets.
How relevant are these findings to the current U.S. economic situation? I would suggest that, while they are of great importance to understanding why the financial meltdown hit the U.S. economy so hard, they are of limited significance at the moment. The U.S. financial system has recovered a great deal of its health.
Of course, all is not necessarily ideal in the U.S. financial system. Outgoing Federal Reserve Governor Daniel Tarullo, one of the main architects of the financial regulations stemming from the 2010 Dodd-Frank Act, suggests that the regulations do need to be adjusted.
Tarullo agrees with those who argue that the regulations are too strict for small banks, for example. He sees the Volcker Rule, a provision of the Dodd-Frank Act that limits commercial banks’ participation in investment banking activities, such as market-making for bonds and other securities, as having unnecessarily hampered trading.
Tarullo’s view, while critical and supportive of change, is a far cry from the radical rollback of the Dodd-Frank Act proposed in the House. That bill would drastically curtail the increased consumer protections offered by the Consumer Financial Protection Bureau. It would also dilute the stronger regulation imposed on large, complex banks.
This amounts to giving the financial industry pretty much their pre-crisis freedom from regulation — freedom that was used recklessly. The IMF paper, in fact, underlines how important it is to avoid another such crisis.
If the financial sector is now fairly healthy, you may ask why productivity growth in the U.S. is still weak? The IMF authors point to a number of factors. The recession lowered the amount of new capital investment, a main way that better, more productive technology comes into use. Additionally, with so many experienced workers losing their jobs and with so many workers retiring, voluntarily or involuntarily, the recession dealt a blow to the skills level in the economy. These factors can have long-lasting effects.
However, some authors point out that the productivity slowdown is longer-lasting and perhaps more troubling than this. In the U.S., productivity growth has been fairly feeble since 2000, a year that marked the bursting of the dot-com bubble. The 2008 crisis pushed productivity growth down even further, but there is reason to think that even a return to the pre-2008 growth rates would not really be enough.
Two possible long-term causes are particularly troubling: the exhaustion of the internet technology revolution and the demographic trend of an aging workforce. The idea of exhaustion of internet technology may sound strange in light of the continued succession of new gadgets and apps in our lives. However, many economists argue that these new innovations are not changing the way business is done nearly as dramatically as the innovations of the 1990’s.
Creating the internet, and applying new technology to inventory and distribution management was a giant leap that cut costs for many companies dramatically; buying everything from Amazon apparently is not.
The second long-term cause — aging — is of course encouraging in that it is the result of greater longevity. It is troubling, however, because the simple demographic facts are hard to change. Other than encouraging immigration of younger people, it would be hard for the U.S. to slow down aging. Helping older workers to be more productive is the logical response, but it is not easy to achieve.
Reversing the productivity growth slowdown should be a central issue in economic policy debates. While economists will disagree on many of the details, it seems clear that stimulating intangible and tangible investment would be crucial.
Most economists would agree that improvements in education and training, R&D and infrastructure that lowers costs for economy-wide functions of transportation, energy provision, training and communication should spur growth.
The how question, of course, divides economists, as well as politicians. But that discussion will have to wait for a future blog post.
Evan Kraft specializes in the economics of transition, monetary policy and banking issues as a professor at American University. He served as director of the research department and adviser to the governor of the Croatian National Bank.
The views expressed by contributors are their own and not the views of The Hill.