Looking At The Future: We Need Growth In Labor Productivity

Quite a few people are turning to Larry Summers, Harvard economics professor and former U.S. Treasury Secretary, these days, hoping to get a better picture of the future.

Mr. Summers, it seems, was correct in his prediction about rising inflation.

James Mackintosh, writing in the Wall Street Journal, admits that he was wrong and Mr. Summers was correct in February 2021.

Mr. Mackintosh writes,

“In February 2021, Larry Summers was right and I was wrong.”

“The former Treasury secretary warned that President Biden’s stimulus package was far too large and would lead to far too high inflation.”

Reason for Mr. Mackintosh’s failure? The Fed didn’t act soon enough.

But, now we are looking at the next stage.

What is going to happen now?

Mr. Summers, we read, is looking at a scene of secular stagnation.

Mr. Mackintosh sees “a new economic regime, with more inflationary pressure and higher real interest rates.”

Mr. Summers imagines that we will go into something like the scenario following the 2008=2009m recession.

Interest rates will remain at low levels because of the increased savings of an aging population and the uncertainty that fills a crisis.

Rapid technological development will again keep the cost of capital low.

The result will be that lower after-inflation interest rate will be all that is needed to balance the economy.

Summers: the yield on the 10-year bond will remain modestly over 3.00 percent. The point: in the evolving scenario, the U.S. and the world, “cannot cope with higher rates.”

Another View

Mr. Mackintosh believes that secular stagnation is less likely.

He believes that fiscal spending will be higher than it was after the Great Recession in 2008-2009.

Globalization will recede and, as a consequence, higher interest rates will be more common throughout the world.

Furthermore, there will be greater empowerment of workers in this evolving world. Stronger labor unions have only just begun to show their new power.

This, too, will lead to greater inflation.

The Federal Reserve, and other major central banks, will have their hands full in trying to fight these new battles throughout the world.

The key here is the decline in global markets and the rise in the disjunction of world markets, leaving different geographic areas creating their own economic structures.

In this picture, as I see it, the world revolves into a greater disequilibrium of out-of-sync economies and markets.

And, Another View

But, let’s take on one more view of the situation, one that also begins with what Larry Summers is thinking.

This viewpoint comes from Arthur Laffer and Stephen Moore, in another opinion piece in the Wall Street Journal.

The criticism here is that Mr. Summers wants to impose five years of austerity on the economy to fully rid the economy of inflation.

“We need five years of unemployment about 5 percent to contain inflation.”

Or, it is suggested, “perhaps one year of 10 percent unemployment.”

As might be expected, Mr. Laffer (and Mr. Moore) wants a supply-side response.

“The secret to curing inflation isn’t economic collapse and high unemployment but the opposite: pro-growth policies that create incentives for more goods, more employment, less government spending and sound money.”

“As the economy produces more, prices go down.”

In effect, this is what I have been talking about over the past year or so. It is these ideas that represent a response to the economic recovery of the past twelve years or so, and within the supply-side concepts of a solution to the current problems.

The Economic Recovery Following The Great Recession

One of the things that stand out in reviewing the data generated within the last period of economic expansion is that the growth of the economy was so sparse.

For the full length of the recovery following the Great Recession. The annual compound rate of growth of the economy was around 2.3 percent. This was the slowest recovery on record.

The apparent reason for this period of slow economic growth is that the growth of labor productivity was almost non-existent, certainly below 1.00 percent, but often around 0.00 percent.

That is, capital investment was not taking place so as to stimulate the growth of labor productivity. Hence, the economy grew very, very slowly for an extended period of time.

The rationale for this goes back a long way and is connected with my research on the government’s efforts to make use of the trade-off between inflation and unemployment as captured by the relationship called “the Phillips Curve.”

Since the mid-1960s, the U.S. government has attempted to attain lower rates of unemployment by generating slightly higher rates of inflation.

This policy approach got built into government policymaking, an approach I have referred to as credit inflation. But, it achieved its goal for many years.

The problem is that investors saw the gains of inflation going into asset prices, like gold prices, house prices, commodity prices, and stock prices.

Business investment took advantage of this and moved to using stimulus monies to buy back their own stock and pay out much higher dividends.

As a consequence, corporate investment management directed funds into these “wealth” builders and from real productive capital investments. Hence, labor productivity declined as more and more “credit inflation” generated asset bubbles and other wealth-generating options.

The height of this period of investment followed the ending of the Great Recession.

Labor productivity growth floundered and economic growth moderated.

Then with the events beginning in 2020, the situation changed. The era of “credit inflation” ended. And, the economy plunged into disequilibrium.

And, this is what Larry Summers picked up on.

Mr. Summers was spot-on with his forecast of inflation,

As far as economic growth was concerned, all Mr. Summers could see was that the federal government pushed to build demand-side programs, stimulate spending in every way possible, and don’t worry about creating more and more debt.

The Supply Side

Mr. Summers was right about what this would do to inflation.

And, he only saw government programs that “goosed up” the demand side of the economy.

He did not look at the other side of the equation and ask what could be done to stimulate growth from the supply side, growth that would be underwritten by faster-growing labor productivity.

This is the other alternative for the Biden administration, one that could “goose-up” economic growth but from the supply-side and keep people working, keep wages rising, and turn the 2020s into a picture of expanding capital productivity.

Mr. Laffer and Mr. Moore are on the right track when they suggest that President Biden end his war on energy, permanent tax cuts, deregulation, and less government spending, accompanied by an immediate tightening of monetary policy by “selling off some of the trillions of dollars of assets on the Federal Reserve balance sheet.”

From this point on, if the U.S. government focuses on the demand side of the equation and attempts to pump more and more money into the economy, inflation will not go away, and monetary policy will become even more ineffective, leaving the Fed with more work in the future having to deal with an even bigger cleanup of the financial system.