Edward Conard

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  • “…a must-read for serious students of economic policy.” - Glenn Hubbard, Dean, Columbia Business School, and former Chairman of the Council of Economic Advisers
  • “…challenges misconceptions that distort our economic debates.” - Arthur Brooks, President of the American Enterprise Institute
  • “…serious thinking for serious thinkers. …a thought-provoking blueprint for growing middle- and working-class incomes.” - Mitt Romney, former Governor of Massachusetts
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Macro Roundup


Monday, May 10, 2021

AI Summary. China's productivity is about 30% of that of leading economies, with business services productivity at 17% of the global frontier, partly reflecting high barriers to entry. Total factor productivity growth slowed from 2.8% a year in the decade before the global financial crisis to 0.7% afterward.

Kenneth Kang International Monetary Fund
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China’s economy only 30% as productive as advanced economies, with aggregate TFP growth slowing from 2.8% 1999-2008 to 0.7% in 2009-2018.

How far does China's productivity lag leading economies?

Core argument: China's economy remains only 30% as productive as the world's leading economies, with business services productivity at just 17% of the global frontier, partly due to high entry barriers.

China's economy, while having experienced significant growth, remains only 30% as productive as the world's leading economies. This productivity gap is particularly pronounced in the services sector, where business services productivity is just 17% of the global frontier, partly due to high entry barriers. Aggregate Total Factor Productivity (TFP) growth has decelerated sharply, from 2.8% in the decade before the global financial crisis to 0.7% between 2009 and 2018. This slowdown has contributed to a decline in GDP growth, which fell below 7% for the first time since 1991 during 2015-18. Despite some signs of improving labor productivity and TFP growth in 2017, these metrics remain significantly lower than pre-crisis levels. The need for institutional reform is emphasized as a critical step towards enhancing resource allocation efficiency and addressing investment misallocation, which could otherwise hinder China's economic potential.

Takeaways by Macro Roundup® AI

  1. China's economy remains only 30% as productive as the world's leading economies, with business services productivity at just 17% of the global frontier, partly due to high entry barriers.
  2. Aggregate total factor productivity growth in China decelerated from 2.8% in the decade before the global financial crisis to 0.7% over 2009–2018.
  3. China's GDP growth fell below 7% during 2015–18 for the first time since 1991, and the staff report emphasizes institutional reform to improve resource allocation and address investment misallocation.

Kenneth Kang and Sanjaya Panth, "Staff Report People's Republic Of China," International Monetary Fund, January 8, 2021, https://www.imf.org/en/Publications/CR/Issues/2021/01/06/Peoples-Republic-of-China-2020-Article-IV-Consultation-Press-Release-Staff-Report-and-49992

“….China has seen remarkable growth over the last decades, but with average sectoral productivity at about one third of the global frontier, there is ample opportunity for more. Productivity gaps are especially large in the services sector—for example, business services productivity stands at only 17 percent of the frontier level, owing in part to high entry barriers…”

Loren Brandt John Litwack Elitza Mileva Luhang Wang Yifan Zhang Luan Zhao, " China’s Productivity Slowdown and Future Growth Potential," World Bank, June 2020, https://openknowledge.worldbank.org/bitstream/handle/10986/33993/Chinas-Productivity-Slowdown-and-Future-Growth-Potential.pdf

World Bank, “…China has experienced a marked slowdown in growth in output per worker since the global financial crisis. In 2015-18, average GDP growth fell below 7 percent for the first time since 1991, to a large extent due to slowing growth in total factor productivity (TFP). Aggregate TFP growth slowed from 2.8 percent in the 10 years before the global financial crisis to 0.7 percent in 2009-18. In 2017, signs of improving labor productivity and TFP growth emerged but both remain significantly lower than their pre-crisis levels. …High investment growth was in part driven by the large fiscal stimulus packages introduced first in in response to the 2009 global recession and later to cushion the 2015-16 growth slowdown (see below). In contrast, TFP growth decreased sharply to 0.7 percent a year in the same period. Other studies also estimate that aggregate TFP has declined in recent years (Wei et al., 2017; Wu, 2017). The TFP growth slowdown is explored further in the following sections…”

Ed, reviewed the IMF report. The report confirmed (see first chart) the WSJ claim, “…China’s economy is only 30% as productive as the world’s best-performing economies …”however it’s data didn’t support, “…The IMF estimates that annual productivity growth averaged just 0.6% between 2012 and 2017, a sharp decline from an average of 3.5% in the previous five years…”However Ben noted a World Bank report that ~ mirrored the WSJ report“…Aggregate TFP growth slowed from 2.8 percent in the 10 years before the global financial crisis to 0.7 percent in 2009-18…” (See second chart)

Michael Pettis, “China’s Economy Needs Institutional Reform Rather Than Additional Capital Deepening," China Financial Markets, July 24, 2021, https://carnegieendowment.org/chinafinancialmarkets/82362

Our friend Mike Pettis commented on the World Bank report when it was published:"...Except to the extent thatthe phrase “improving the efficiency of resource allocation” is carrying an extraordinarily heavy load, I think this is likely to be the wrong approach and will lead mainly to more investment misallocation in the country. What China really needs is a transformation of its institutions in a direction that some might argue is very different from the direction it is currently following...."

Ed Comment:Surprising. Mark important and add to data base. What accounts for the 3x (=1/0.30) difference in our productivity vs China—capital per worker, human capital per worker (i.e. education), or TFP? Perhaps they can close much of the gap with our productivity by investing more capital per worker. That would be relatively easy. So would increasing levels of education. It might be hard to close a TFP gap if they are only growing TFP 0.6% a year (about the same rate as us). What do your 2 china buddies say about this.

Steve Comment:If you are interested Nick Lardy book from a few years ago The State Strikes Back does a great job flushing out the dynamics driving what you are describing. Under Xi they have tacked away from private market driven growth and are currently shrinking the role for private firms (so raising the role of SOE) and the market in the overall economy (Jack Ma’s disappearance is a good illustration), Lardy forecast that was going to slow productivity growth which the World Bank and IMF are now picking up. The men who run China understand that market economies diffuse power in a way that would threaten the CCP control, and it’s a good bet they will always optimize towards maintaining the CCP monopoly on power despite the tradeoffs, slower productivity growth for example. The shift under Xi shows it’s in fact a deliberate choice. Now that is likely enough for their middle term goals (for example in practical terms the PLAN likely has the USN beat today in terms of the distribution of relevant resources) as this chart of military spending inppP terms implies:

Ben Comment:The report also mentions that some of the service industries with the highest productivity gap are the least competitive: "Productivity gaps are especially large in the services sector—for example, business services productivity stands at only 17 percent of the frontier level, owing in part to high entry barriers.” It will also come as no surprise that the state operated enterprises (SOEs) are less productive than private firms. The graph I’m attaching says, while SOEs are declining in relative importance, they’re still important users of capital and credit. My interpretation is that SOEs are not allowing private firms to reach the scale they’d need to become big drivers of productivity and productivity growth. There also seems to be a geographic mobility issue: "Urbanization has helped rural workers to find work in economically active regions, where household incomes are twice as high as in rural areas. A more holistic reform to further improve the hukou system, preserve migrant worker land ownership rights, improve the efficiency of rural land markets, and increase spending on public services and social safety nets, would facilitate labor market mobility and raise growth.”Taken together - it looks to me like China’s productivity lag is unlikely to disappear because the reforms necessary (SOE reform, opening markets, mobility, etc) are unlikely to be popular among the control-obsessed Chinese government. I think will take a lot more than just capital deepening. The World Bank Report graph Steve pulled out shows that the Chinese are adding tons of capital per worker but not very much human capital and very little TFP. The increased capital is unlikely to be that productive if, as the IMF claims, it’s going into poorly run SOEs. So it seems like the Chinese are behind in all three: capital per worker, human capital per worker (i.e. education), and TFP, and they’re struggling to close the gap because they have institutional and structural issues that would make catch up hard even if capital per worker and human capital (education) investment increase.

Wednesday, May 12, 2021

AI Summary. The authors estimate that aggregate markups over cost rose from 18% to nearly 67% between 1980 and 2014, concentrated among firms that already had high markups, which they interpret as a rise in market power. They associate this increase with declining labor and capital shares, lower low-skill wages, reduced labor force participation, fewer startups, and wider wage inequality.

De Loecker, Jan, Jan Eeckhout, and Gabriel Unger National Bureau of Economic Research
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According to @DeLoockerJan @JanEeckhout @GabrielUnger, aggregate markups have surged from 18% to nearly 67% since 1980, driven by firms with already high markups, indicating a rise in market power.

Have rising markups reshaped wages, labor shares, and business formation?

Core argument: Aggregate markups rose from 18% in 1980 to nearly 67% by 2014, driven by firms that already had high markups, indicating a rise in market power.

Since 1980, aggregate markups have surged from 18% to nearly 67% by 2014, driven by firms with already high markups, indicating a rise in market power. This increase correlates with several macroeconomic trends: a decline in labor and capital shares, reduced low-skill wages, and decreased labor force participation. Additionally, the startup rate of new firms has fallen due to higher barriers, while wage inequality has risen as low-skill wages decrease and skilled wages increase. The rise in market power has also led to higher inflation rates than would have occurred without it, suggesting that anti-trust policy, rather than monetary policy, is needed to address this inflation. Furthermore, the stock market is overvalued relative to a competitive economy, as current profit levels are significantly higher than in 1980. Technology plays a crucial role in enabling firms to maintain market power, with no signs of a substantial decrease in markups in the near future.

Takeaways by Macro Roundup® AI

  1. Aggregate markups rose from 18% in 1980 to nearly 67% by 2014, driven by firms that already had high markups, indicating a rise in market power.
  2. The rise in market power correlates with declining labor and capital shares, lower low-skill wages, reduced labor force participation, a falling startup rate amid higher barriers, and wider wage inequality.
  3. Market power has produced higher inflation than would have occurred otherwise, suggesting anti-trust rather than monetary policy as the remedy, and leaves the stock market overvalued relative to a competitive economy.

New NEBR paper, suspect will be hearing for about it from the left as it's arguing that the decline of the labor share, decline of capex, as well as the decline in low-skilled wages all are given a tailwind by the increase in markups and market power

given that within industry they found the highest markups went to firms that already had the highest markups seems like it could be the rise of superstar firms as opposed to market power.

"...Using micro data on the accounts of publicly traded firms in the US starting in 1950, we find that markups have been relatively constant between 1950 and 1980 at around 20% above marginal cost. From 1980 onwards, there has been marked change in this pattern with markups steadily rising from 18% to nearly 67% in 2014, a three and a half fold increase. We have documented the properties of this rise, which is mainly due to a change within industry, and which can be attributed mostly to the increase of markup of the firms with the highest markups already.Markups tend to be larger in smaller firms, but this seems to be due mainly to a composition effects across industries as this disappears when we decompose the markup at the fine industry level. We use this increase to investigate the implications this has for secular macroeconomic trends in the last decades: 1. decrease in labor share; 2. decrease in capital share; 3. decrease in low skill wages; 4. decrease in labor force participation; 5. decrease in labor flows; 6. decrease in migration rates; 7. slowdown in output and GDP. There are of course other secular trends that happen to coincide with the increase in market power: 1. decrease in startup rate of new firms due to higher barriers erected by incumbents 2. decrease in the long term interest rate due to the fall in demand for capital (due to quantity reduction of firms with market power) and an increase in the supply of capital (due to higher profits); 3. the increase in wage inequality46 from to the decrease in low skill wages as documented above together with an increase in skilled wages due to profit sharing by managers; 4. the great moderation, or the idea that output fluctuations have decreased since 1980, has lost appeal since the great recession, but which is still very much observed in the data, especially in the last decade, with of course, the notable exception of 2008. As we have shown, with incomplete pass-through the same individual firm level productivity shocks lead to lower output adjustments. There is evidence however that the transmission of aggregate shocks is also incomplete. As a result, higher market power would translate in smaller aggregate fluctuations GDP in response to aggregate shocks as well. While we believe that each of these four secular trends are as important as, if not more important than, the ones we have analyzed, we leave them as a priority for future research. There are two profound policy consequences that result from the rise in market power.The first relates to inflation. Relative to a scenario without a rise market power and with the same evolution of technology, prices would have gone up by 1% per year (42% over 35 years, from 1.18 to 1.67). This implies that inflation has been higher than it would have been without the rise in market power.This is surprising given the low inflation rates in the last decades - and particularly low ones since the great recession. Of course, monetary policy is not the appropriate policy tool to remedy that source of inflation. That would be the prerogative of anti-trust policy. The second consequence pertains to the value of the stock market. Stocks prices reflect the discounted flow of dividends and thus profits. The stock market under market power is therefore overvalued relative to a competitive economy. If investors believe that the current profit level that is four times higher than in 1980 is permanent, then we would expect that the stock market capitalization would be four time higher than under perfect competition. That would put the Dow Jones at 5,500 instead of its nearly 22,000 level today. Of course, that is a naïve calculation since market capitalization also reflects the extensive margin, the total value of goods sold, and that decreases with market power. How big the effect of market power is on the stock market value depends on the elasticity of demand. Note also that the stock market can go up if output deceases, for example when productivity growth is zero and market power and hence profits increase. In the presence of market power, the stock market is therefore not a good gauge of an economy’s output. While we have focused on the consequences of the rise in market power, in this paper we have remained silent on the causes. Especially when it comes to finding remedies, it is essential to understand the causes. We limit ourselves to listing a number of candidate explanations: the rise of merger & acquisition activity (Figure B.9 in the Appendix), deregulation, the higher share of network goods, the increase in wholesale transaction (Ganapati (2016)), private equity, improved product differentiation, increased vertical and financial integration of competitors. A common factor in each of these is technology. Rapid technological change allows firms to better create and preserve situations of market power. Markups are reaching heights multiple times higher than ever seen, at least since the second world war when our data start. It is open to speculation whether this trend will continue, but for now there are no signs that markups will decrease substantially any time soon..."

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De Loecker, Jan, Jan Eeckhout, and Gabriel Unger. November 22, 2018. “The Rise of Market Power and the Macroeconomic Implications.” NBER.http://www.janeeckhout.com/wp-content/uploads/RMP.pdf