The Great Recession, productivity and productivity growth
By Scott Sumner
The sharp reduction in productivity growth since 2004 is one of the most notable recent trends in macroeconomics. Not surprisingly, some pundits have suggested that this slowdown is linked to the Great Recession.
In the most simple business cycle models, output returns to the natural rate once wages and prices have adjusted. In that case, demand shocks have only a transitory impact on output. But recessions don’t just cause unemployment; they also reduce investment, which leads to a smaller capital stock. In that case, might the Great Recession permanently reduce productivity and output? Probably not, but the impact of a smaller capital stock might be so long lasting that it seems permanent. Even 8 years after the trough of the Great Recession, productivity and real output might be lower than if the Great Recession had never occurred.
Unfortunately, this doesn’t really help us understand why recent productivity growth is so anemic. That’s because the very same models that allow recessions to have a highly persistent effect on productivity, also predict exactly the opposite effect on productivity growth. Thus if our capital stock was artificially depressed by a low level of investment during the Great Recession, then the marginal product of new capital should increase, and the level of investment should also increase. Our economy is more labor intensive than if there had been no Great Recession, and this should lead to a higher than normal level of investment.
In other words, if the level of productivity was semi-permanently depressed by the Great Recession, then the current growth rate of productivity should be higher than normal. But we observe exactly the opposite—productivity growth is unusually low.
To summarize, we don’t know why productivity growth is so low (I suspect it is related to the economy’s shift to services, as well as hard to measure stuff on the internet) but it is not caused by the Great Recession. Indeed you’d expect growth to be faster
than after a deep slump. And indeed growth was faster than normal after the deep slumps of 1920-21, 1929-33, 1937-38, 1974-75, and 1981-82. This is the only deep slump (in America) followed by slower than normal growth.
In my view, it’s a waste of time trying to construct a business cycle model where a deep slump permanently reduces the economy’s growth rate. That’s because if you “succeed” in explaining 2008-09, then you immediately unexplain what we thought we new about the 5 earlier slumps mentioned above. Why would anyone wish to solve one problem at the cost of creating five brand new problems? Better to treat this recovery as an anomaly, and look for reasons why productivity growth began slowing after 2004.
Some people ask me if I really think it’s a “coincidence” that long run trend growth started slowing at roughly the time of the Great Recession. Yes I do. I would have a much harder time accepting 5 improbable coincidences, the hypothesis that deep slumps will normally reduce GDP growth rates, but that this did not occur during the previous 5 deep slumps because each time some sort of mysterious exogenous factor came to the rescue. How likely is that?
PS. Elsewhere I’ve argued that the slowdown in productivity growth helped to cause the Great Recession. That’s because it depressed the Wicksellian natural rate of interest to a level below where the Fed thought it was, and this caused the Fed to tighten policy more than they anticipated.