Some Big Changes in Macroeconomic Thinking from Lawrence Summers
A lot of economists, myself included, have spoken about the need to fundamentally rethink major parts of macroeconomics following the global financial crisis. At a truly fascinating and intense conference on the global productivity slowdown we hosted earlier this week, Lawrence Summers put forward some newly and forcefully formulated challenges to the macroeconomic status quo in his keynote speech. These were broad empirical observations that raised questions about some of the standard assumptions that macroeconomists have tended to make—including some taken for granted by mainstream New Keynesians. Challenging assumptions is the basis for progress, though all of us in the profession have a lot of work to do as a result of these and other disturbing questions.
The first point Summers raised went right to the heart of the conference, and more importantly to the discussion of the productivity slowdown. He pointed out that a major global trend over the last few decades has been the substantial disemployment—or withdrawal from the workforce—of relatively unskilled workers. In the United States, since 1965, there has been a tripling of the non-employment rate for men between the ages of 24 and 54, and similar trends have been observed elsewhere—even in China, there are today 20 million fewer manufacturing workers than there were in 1995. All else being equal, though, that should lead to a rise in measured productivity: Presumably, this shift in production work is due to technological replacement of workers, especially since it took place across countries from the United States to China simultaneously,1 in which case output per worker should be rising; since it is unskilled workers who are disproportionately leaving employment, this should also lead to rising productivity as the average of remaining workers' productivity goes up.
In other words, it is a real puzzle to observe simultaneously multi-year trends of rising non-employment of low-skilled workers and declining measured productivity growth. Either we need a new understanding, or one of these observed patterns is ill-founded or misleading. In my view, we should trust labor market data more than GDP data when they come in conflict—workers are employed and paid, and pay taxes (usually) so they get directly counted, whereas much of GDP data is constructed. Thus productivity, as the residual of GDP minus capital and labor accumulation, is much less reliable than the directly observed count of workers. This is the view I expressed when confronted with the equally strange juxtaposition of positive employment growth and outright declining measured labor productivity in the United Kingdom during the crisis: The productivity numbers must be wrong.
Summers simply posed the labor and productivity puzzle as something significant and difficult to understand, but he then proposed another significant reason that productivity growth may be increasingly underestimated for technological reasons today. He argued that there has been unmeasured quality improvement, whether in health care or travel, or in intangible services in general. Most people would rather have contemporary health care at current prices than 1983 health care at 1983 prices, for example, which indicates that for all the talk about healthcare inflation, the actual value people put on the services they get has gone up more than the prices have. The fraction of the economy that is composed of those kinds of services has been rising, so the amount of mismeasurement (and therefore productivity understatement) would be rising over time.
Experts on productivity have long considered these issues, however, and many believe that there is little reason to believe that mismeasurement has gotten worse over time. Presentations at our conference by the noted empirical growth researchers John Fernald and Robert Gordon, for example, took on directly some of the more widely-held mismeasurement claims; to correct for these technological developments, they argue that the timing on the shifts in observed productivity is wrong or the inflation measures are right. An exchange between Fernald and Summers in the Q&A session suggested that a possible way forward to resolve these issues would be to compare how countries measure and treat the output and inflation of common new technologies.
Substantial underestimation of US productivity growth, if it is true, has substantial implications for monetary policy today beyond its import for our overall assessment of economic performance. As Summers argued in his speech, if you take underestimation of productivity growth seriously, you have to take into account the significant risk that inflation is lower than even its currently low level—and that has the consequence that real interest rates are higher, so monetary policy at present is tighter than people realize, but also farther away from its mandated inflation target than recognized. That would clearly be an additional argument to take into consideration against the Federal Reserve tightening policy in the near-term. I personally have been against the Fed raising rates prematurely, given the low inflation outlook and the downside risks from the global economy, and this only adds weight to my concern about future inflation being too low.
Another related major challenge to standard macroeconomics Summers put forward that struck me came in response to a question about whether he exaggerated the displacement of workers by technology. As forthrightly stated in his reply, it has long been a mark of sophistication amongst economists to say that while productivity may remove specific jobs, because it produces more income overall, it should still be consistent with full employment over time as new jobs get created—economists thought only the simple-minded would assume that jobs simply disappear without being restored in general equilibrium.
Then Summers bravely noted that if we suppose the "simple" non-economists who thought technology could destroy jobs without creating replacements in fact were right after all, then the world in some aspects would look a lot like it actually does today: Relative wages of those subject to technological displacement, or the unskilled, would go down; fewer would be employed, whether by choice or not, as a result; and labor input is permanently reduced. This is very scary if correct (and not just because economists would have to again cease being smug). Unless we can somehow transform that sustained lower demand for workers into the widespread leisure of the sort imagined by Keynes and some science fiction writers, with the income redistribution to support it, I would think this is very bad news for social stability and technological progress.
The third challenge to mainstream macroeconomics Summers raised is perhaps the most profound, and is briefly posed in the last section of his speech. In a working paper the Institute just released, Olivier Blanchard, Eugenio Cerutti, and Summers examine essentially all of the recessions in the OECD economies since the 1960s, and find strong evidence that in most cases the level of GDP is lower five to ten years afterward than any prerecession forecast or trend would have predicted. In other words, to quote Summers' speech at our conference, "the classic model of cyclical fluctuations, that assume that they take place around the given trend is not the right model to begin the study of the business cycle. And [therefore]…the preoccupation of macroeconomics should be on lower frequency fluctuations that have consequences over long periods of time [that is, recessions and their aftermath]."
I have a lot of sympathy for this view. When discussing a recent paper on the disappointment we have with Abenomics' results in terms of inflation and output in Japan, despite the Bank of Japan pursuing the monetary policy that I and others have advocated, I asked whether a message we should take from the Japanese experience is to avoid bad states of the economy at almost any cost.2 Yet, the Blanchard-Cerutti-Summers argument (and now empirical evidence) for hysteresis is hugely disturbing if it holds true as a general characterization (leaving aside the very real difficulties of making this conclusion definitive, given the limited number of cases and massive number of factors involved—a difficulty that Summers clearly acknowledges). The very language we use to speak of business cycles, of trend growth rates, of recoveries of to those perhaps non-stationary trends, and so on—which reflects the underlying mental framework of most macroeconomists—would have to be rethought.
Productivity-based growth requires disruption in economic thinking just as it does in the real world.
2. See Adam S. Posen, "Discussion of 'Abenomics: An Update,'" Brookings Panel on Economic Activity, September 11, 2015, forthcoming BPEA, Fall 2015.