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Policy Hub: Macroblog provides concise commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues for a broad audience.

Authors for Policy Hub: Macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

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September 26, 2013

The New Normal? Slower R&D Spending

In case you need more to worry about, try this: the pace of research and development (R&D) spending has slowed. The National Science Foundation defines R&D as “creative work undertaken on a systematic basis in order to increase the stock of knowledge” and application of this knowledge toward new applications. (The Bureau of Economic Analysis (BEA) used to treat R&D as an intermediate input in current production. But the latest benchmark revision of the national accounts recorded R&D spending as business investment expenditure. See here for an interesting implication of this change.)

The following chart shows the BEA data on total real private R&D investment spending (purchased or performed on own-account) over the last 50 years, on a year-over-year percent change basis. (For a snapshot of R&D spending across states in 2007, see here.)

Real Spending on Research and Development


Notice the unusually slow pace of R&D spending in recent years. The 50-year average is 4.6 percent. The average over the last 5 years is 1.1 percent. This slower pace of spending has potentially important implications for overall productivity growth, which has also been below historic norms in recent years.

R&D spending is often cited as an important source of productivity growth within a firm, especially in terms of product innovation. But R&D is also an inherently risky endeavor, since the outcome is quite uncertain. So to the extent that economic and policy uncertainty has helped make businesses more cautious in recent years, a slow pace of R&D spending is not surprising. On top of that, the federal funding of R&D activity remains under significant budget pressure. See, for example, here.

So you can add R&D spending to the list of things that seem to be moving more slowly than normal. Or should we think of it as normal?

Photo of John RobertsonBy John Robertson, vice president and senior economist in the Atlanta Fed’s research department


August 16, 2013

GDP, Jobs, and Growth Accounting

The latest on productivity, from the Associated Press via USA Today:

U.S. worker productivity accelerated to a still-modest 0.9% annual pace between April and June after dropping the previous quarter.

The second-quarter gain...reversed a decline in the January-March quarter, when the Labor Department's revised numbers show productivity shrank at a 1.7% annual pace.

Labor costs rose at a 1.4% annual pace from April through June, reversing a revised 4.2% drop the previous quarter.

Productivity measures output per hour of work. Weak productivity suggests that companies may have to hire because they can't squeeze more work from their existing employees....

Productivity growth has been weaker recently, rising 1.5% in 2012 and 0.5% in 2011.

Annual productivity growth averaged 3.2% in 2009 and 3.3% in 2010. In records dating back to 1947, it's been about 2%.

Though not quite in the category of spectacular—and coming off revisions that if anything made things look weaker than previously thought—last quarter's uptick is a welcome development. Earlier this week, in a speech to the Atlanta Kiwanis club, Atlanta Fed President Dennis Lockhart laid out several scenarios with materially different implications for how the GDP and employment picture might play out over the next several years:

As a matter of arithmetic, healthy employment growth coupled with tepid GDP growth implies weak labor productivity growth. And in fact, productivity growth in recent quarters has been significantly below historical norms.

[I] believe that the recent low growth of productivity is probably just a temporary downdraft after the rather strong productivity growth when the economy emerged from recession.

If productivity growth rebounds to more typical levels, the coincidence of job gains at a pace of around 190,000 per month in recent months and GDP growth below 2 percent cannot persist. Again, it's a matter of arithmetic. Either GDP growth will rise to levels consistent with recent employment growth, or employment growth will fall to levels more consistent with the weak GDP data we've been witnessing.

I've got a working assumption on this question, and it is captured in the Atlanta Fed's baseline forecast for the second half of this year and 2014. This outlook calls for a pickup in real GDP growth over the balance of 2013, with a further step-up in economic activity as we move into 2014.

You can get a sense of this outlook by considering the output of one particular model that we use here at the Atlanta Fed. The model, which is purely statistical, gives us a view into how productivity, GDP, employment, and the unemployment rate might move together (along with other labor market variables like labor force participation and average hours worked). Here is the bottom line of an exercise that assumes GDP growth through 2015 comes in at about the central tendency of the projections from the Federal Reserve's June 2013 Summary of Economic Projections.

For this exercise, we have adjusted the 2013 growth forecast down slightly due to the weaker-than-expected growth in the first half of the year. Additionally, we have plugged in assumptions for productivity growth—1.5 percent per quarter (SAAR), the average gain over the past eight years—and nonfarm business output growth. We then let the model forecast the remaining variables, all of which are for the labor market:

130816a

The model forecasts employment gains in the neighborhood of what the economy has been generating over the past several years, and a steadily declining unemployment rate.

Now consider two "stall" scenarios in which GDP growth fails to get beyond 2.3 percent. The first of these scenarios is the one noted in the Lockhart Kiwanis speech, with productivity recovering but job growth falling off the pace:

130816b

From a policy perspective, this one may not cause too much handwringing about the appropriate course of action. The weak GDP growth is accompanied by a failure to make the type of progress on the unemployment rate that the FOMC has clearly articulated as the necessary condition for adjustments in policy rates:

[T]he Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

Absent unforeseen issues with inflation, staying the course would seem to be in order.

But there is a second stall scenario in which productivity and GDP growth remain tepid, even as labor market indicators improve:

130816c

The difference in this experiment is that the expectations of those that President Lockhart referred to in his speech as the "innovation pessimists" are correct. Recent weakness in productivity growth reflects a fall in trend productivity growth. In this case, essentially identical labor market outcomes would nonetheless correspond to an economy that can't seem to hit "escape" velocity.

If it is clear that this configuration of outcomes is associated with a structural break in productivity growth, an argument against monetary policy stimulus would have some weight. After all, in most cases we don't expect the tools of monetary policy to fix structural efficiency problems.

But, alas, such clarity rarely arrives in real time. The experiments above give some sense of how difficult it can be to discover the right branch to follow on the policy decision tree.

Photo of Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed


February 1, 2013

Half-Full Glasses

Just in case you were inclined to drop the "dismal" from the "dismal science," Northwestern University professor Robert Gordon has been doing his best to talk you out of it. His most recent dose of glumness was offered up in a recent Wall Street Journal article that repeats an argument he has been making for a while now:

The growth of the past century wasn't built on manna from heaven. It resulted in large part from a remarkable set of inventions between 1875 and 1900...

This narrow time frame saw the introduction of running water and indoor plumbing, the greatest event in the history of female liberation, as women were freed from carrying literally tons of water each year. The telephone, phonograph, motion picture and radio also sprang into existence. The period after World War II saw another great spurt of invention, with the development of television, air conditioning, the jet plane and the interstate highway system…

Innovation continues apace today, and many of those developing and funding new technologies recoil with disbelief at my suggestion that we have left behind the era of truly important changes in our standard of living…

Gordon goes on to explain why he thinks potential growth-enhancing developments such as advances in healthcare, leaps in energy-production technologies, and 3-D printing are just not up to late-19th-century snuff in their capacity to better the lot of the average citizen. To paraphrase, your great-granddaddy's inventions beat the stuffing out of yours.

There has been a lot of commentary about Professor Gordon's body of work—just a few examples from the blogosphere include Paul Krugman, John Cochrane, Free Exchange (at The Economist), Gary Becker, and Thomas Edsall (who includes commentary from a collection of first-rate economists). Most of these posts note the current-day maladies that Gordon offers up to furrow the brow of the growth optimists. Among these are the following:

And inequality in America will continue to grow, driven by poor educational outcomes at the bottom and the rewards of globalization at the top, as American CEOs reap the benefits of multinational sales to emerging markets. From 1993 to 2008, income growth among the bottom 99% of earners was 0.5 points slower than the economy's overall growth rate.

Serious considerations, to be sure, but there is actually a chance that some of the "headwinds" that Gordon emphasizes are signs that something really big is afoot. In fact, Gordon's headwinds remind me of this passage, from a paper by economists Jeremy Greenwood and Mehmet Yorukoglu published about 15 years ago:

A simple story is told here that connects the rate of technological progress to the level of income inequality and productivity growth. The idea is this. Imagine that a leap in the state of technology occurs and that this jump is incarnated in new machines, such as information technologies. Suppose that the adoption of new technologies involves a significant cost in terms of learning and that skilled labor has an advantage at learning. Then the advance in technology will be associated with an increase in the demand for skill needed to implement it. Hence the skill premium will rise and income inequality will widen. In the early phases the new technologies may not be operated efficiently due to a dearth of experience. Productivity growth may appear to stall as the economy undertakes the (unmeasured) investment in knowledge needed to get the new technologies running closer to their full potential. The coincidence of rapid technological change, widening inequality, and a slowdown in productivity growth is not without precedence in economic history.

Greenwood and Yorukoglu go on to assess, in detail, how durable-goods prices, inequality, and productivity actually behaved in the first and second industrial revolutions. They conclude that game-changing technologies have, in history, been initially associated with falling capital prices, rising inequality, and falling productivity. Here is a representative chart, depicting the period (which was rich with technological advance) leading up to Gordon's (undeniably) golden age:

Mbchart130201
Source: "1974," Jeremy Greenwood and Mehmet Yorukoglu,
Carnegie-Rochester Conference Series on Public Policy, 46, 1997


Greenwood and Yorukoglu conclude their study with this pointed question:

Plunging prices for new technologies, a surge in wage inequality, and a slump in the advance of labor productivity - could all this be the hallmark of the dawn of an industrial revolution? Just as the steam engine shook 18th-century England, and electricity rattled 19th-century America, are information technologies now rocking the 20th-century economy?

I don't know (and nobody knows) if the dark-before-the-dawn possibility described by Greenwood and Yorukoglu is the apt analogy for where the U.S. (and global) economy sits today. (Update: Clark Nardinelli also discussed this notion.) But I will bet you there was some commentator writing in 1870 who sounded an awful lot like Professor Gordon.

Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed

March 4, 2011

Gaining perspective on the employment picture

The employment report released today indicated a moderate increase of 192,000 in nonfarm payrolls and a slight decline in the unemployment rate from 9 percent in January to 8.9 percent. While certainly an improvement over recent months, employment growth still has not reached a level needed to produce significant drops in the unemployment rate.

In a speech given yesterday, Atlanta Fed President Dennis Lockhart addressed some of the underlying issues that have potentially been holding back job growth. On the supply side, President Lockhart addressed three structural issues, including skill mismatch, house lock, and extended unemployment insurance.

"Skill mismatch exists when work skills of job seekers do not match the requirements of jobs that are available. For example, a construction worker is unlikely to have the particular skills needed in the healthcare industry."

This comment is motivated by the research of Federal Reserve economists (Valetta and Kuang and Barnichon and Figura, among others) that suggests while there is likely some evidence of skill mismatch, it's not materially different than what's been seen during past recessions.

Another possible explanation mentioned by President Lockhart for persistently high unemployment is the existence of  what is sometimes referred to as "house lock."

"Currently many people owe more on their homes than their homes are worth. It's claimed that job seekers don't accept jobs available in other geographic locations because of the difficulty or cost of selling their homes."

Here too, President Lockhart says there is evidence indicating house lock is not a large contributor to the current high level of unemployment (For example, see Schulhofer-Wohl, Kaplan and Schulhofer-Wohl, and Molloy et al.)

More convincing is the argument pointing to the impact of extended unemployment insurance benefits. Research from the most recent recession and recovery—for example, see Valetta and Kuang and Aaronson et al.—suggests extended benefits have added to the unemployment rates, with estimates ranging from 0.4 percentage points to 1.7 percentage points. If that's the case, then President Lockhart says these extended benefits may be acting "as a disincentive to accept an offered job, especially if the job pays less than the one lost."

As President Lockhart indicates, however, standard skill mismatch, house lock, and unemployment insurance disincentives do not provide the full answer. So, he offers some additional factors:

"On the demand side, it's been argued that credit constraints affecting small businesses are holding back hiring. Banks are blamed for this situation and so are regulators. Getting credit at an affordable cost was a challenge during the recession. But credit conditions for established small businesses have been steadily improving for some time now. Recent surveys suggest that most small businesses are cautious about hiring more because of slow sales growth rather than lack of access to credit.

"Furthermore, a recent National Bureau of Economic Research study showed that job creation is more correlated to young businesses than the broad class of small businesses. Start-ups and young businesses are often financed in ways other than direct business loans. Difficulties getting home equity loans and other personal credit appear to have reduced formation of new businesses.

"Strong productivity growth is another much-discussed potential impediment to hiring. Stated simply, increases in productivity allow businesses to support a given level of sales with fewer people. In the longer term, rising productivity expands the economy's output, which in turn generates jobs. But in the short run, productivity investment can be the enemy of employment growth.

"Productivity growth was unusually high during the recession and in the early stages of the recovery, limiting the need for additional workers. Recently, however, productivity growth has slowed below the pace of business sales. If this trend continues, the need to hire additional workers will increase.

"Finally, in recent months, reluctance to hire has been attributed to heightened uncertainty, a common theme among my business contacts. A few weeks ago I argued that uncertainty has abated somewhat with the improving economy, the resolution of the November elections, the extension of tax cuts, and the apparent containment of the European sovereign debt crisis. I said that before Tunisia and before the fiscal struggle in Congress gathered steam. The restraining influence of uncertainty persists, to some extent."

Outside of productivity, it is difficult to measure the impact of these issues. (For example, it is difficult to survey people who did not start up a firm to determine if credit was an issue.) However, the theme of uncertainty has been a consistent factor in discussions on employment with our contacts here at the Atlanta Fed. If a simple explanation for persistent weakness in labor markets has proven elusive, there is little argument with President Lockhart's observation that "the recovery has brought little relief to the labor market."

Should today's employment release change any opinions about the strength of the labor market? In my mind, not really. There are still 7.5 million fewer jobs than at the start of the recession. There are also still over 8 million workers employed part time for economic reasons, and almost 6 million of the unemployed have been so for more than 26 weeks.

But the numbers released today did provide some additional evidence that the labor market is moving in the right direction with a level of growth consistent with at least a modest decline in unemployment. Furthermore, as consumer expenditures continue to rise, profitability increases, and the amount of uncertainty diminishes, hiring should increase. However, as President Lockhart alluded to in his speech, it will likely take time before the labor market recovery catches up to the overall economic recovery.


Photo of Melinda Pitts By Melinda Pitts
Research economist and associate policy adviser at the Atlanta Fed