Macro Roundup

In March, the Labor Department reported that total factor productivity, or TFP, in the private nonfarm business sector increased 3.2 percent in 2021. That was the largest growth since 1983.The below chart comes from the San Francisco Fed, and includes a modified TFP measure that attempts to smooth out business cycle noisiness.

James Pethokoukis, "Good News, Bad News on US Productivity Growth,"American Enterprise Institute, May 6, 2022, https://www.aei.org/economics/good-news-bad-news-on-us-productivity-growth/

Good News, Bad News on US Productivity Growth

I only wish US productivity growth were as consistently strong as job growth. (The economy added 428,000 jobs in April, making it 12 consecutive months of employers adding at least 400,000 new jobs.) On Thursday, the Labor Department reported that non-farm business productivity fell at a 7.5 percent annualized pace, the sharpest quarterly decline in 75 years. “The mother of all productivity declines,” is how Capital Economics described it.

Of course, productivity numbers are famously volatile, and that seems to be especially true during this pandemic era. Then again, it’s not the first lousy number. From a CE research note:

is now up only 2.6% since the fourth quarter of 2019, which translates into an annualized pace of little more than 1%. Pandemic-related shifts like working from home and increased capex provided no meaningful boost to labor productivity.

And here’s JPMorgan’s take (bold by me):

Nonfarm productivity dropped 7.5% saar in 1Q on the combination of a 2.4% decline in output and a 5.5% increase in hours worked. Unit labor costs, meanwhile, surged 11.6% saar in 1Q. These 1Q figures were very close to our expectations, but the productivity reading disappointed the consensus and the unit labor costs figure beat the consensus forecast. The data can be choppy, and the 1Q swings likely are not fully indicative of the underlying trend. But as the recovery continues and the labor market keeps tightening, we think that the trend in productivity will moderate and the trend in unit labor costs will firm and these expectations have been broadly playing out through some of the noise in the quarterly readings.

Of course, I hope that we see rapid productivity growth, not just moderation in the current trend. This would be due to pandemic-related trends such as work-from-home and more e-commerce, but also greater diffusion of AI into the economy and perhaps a pro-productivity boost from the 2021 infrastructure bill.

And not all the news is bad. In March, the Labor Department reported that total factor productivity, or TFP, in the private nonfarm business sector increased 3.2 percent in 2021. That was the largest growth since 1983. (TFP is that part of economic growth that can’t be explained by production inputs, such as the number of hours worked or the amount of capital used. This unexplained bit presumably reflects advances in production technologies and processes.) The below chart comes from the San Francisco Fed, and includes a modified TFP measure that attempts to smooth out business cycle noisiness.

John Authers, "Bond Landmarks Hint at Revenge of the Monetarists,"Bloomberg, May 3, 2022, https://www.bloomberg.com/opinion/articles/2022-05-03/bond-market-landmarks-hint-at-revenge-of-the-monetarists

Bond Landmarks Hint at Revenge of the Monetarists

Quantitative Tightening: Very, Very Frightening?

Another Monday, another set of landmarks in the bond market. The yield on 10-year Treasury Inflation-Protected securities, or TIPS, is positive again. After its longest ever stay in negative territory, the “real” post-inflation rate at which to borrow or lend money over 10 years is now higher than at the beginning of the pandemic. This startling surge has brought to an end another element of the monetary desperation tactics that followed the lockdowns of March 2020:

Here’s my best attempt at a summary of the claims and counterclaims:

Tightening Is Already Working

Look at broad measures of money in the system, and growth has already plummeted in spectacular fashion. After an extraordinary expansion in 2020, year-on-year changes in both the euro zone and the U.S. are back to normal ranges, though still toward the top. Extreme growth is over, and will continue to slow from here:

In taking this view, Watling shows an unfashionable confidence in the ability of central banks to clean up their own mess, and more importantly he suggests that there is enduring truth in monetarism, famously summed up by Milton Friedman with the contention that inflation is always and everywhere a monetary issue. Money supply, more than anything else, in other words, drives prices.

The last two years have provided an interesting experiment which could tell us whether Friedman and the monetarists have been right all along. The British economist Tim Congdon, best known as one of the intellectual parents of “Thatcherite” economics in the 1980s, is confident that he is in the process of being proved correct. Exhibit a) might be that the economies that really opened the monetary spigots two years ago now have a serious inflation problem, and those that didn’t don’t. For a reminder, this is how money growth accelerated over the main pandemic period:

Congdon’s analysis isn’t all encouraging for markets, however. Even if inflation is a monetary problem susceptible of a monetary cure that is already being administered, the peak might not yet be in. Friedman showed that monetary policy acts with a significant lag. The extra demand for wages, in particular, is still working its way through the system.

Much hope has been put in “base effects” as April, May and June of last year all saw very high rises in prices. However, Congdon points out that from July to September monthly inflation was much lower — 0.45%, 0.33% and 0.42% respectively. He goes on:"The underlying rate of inflation in the USA - driven by domestic labour costs, above all - is now well above these figures. (The increase in hourly earnings in January was just above 0.6%, implying an annual rate of almost 8% - and the rate of increase has been surging in the last few months.) Suppose that the monthly CPI increases in July, August and September are ¾%, which seems reasonable. Then the annual rate of increase for September - announced in October - will be about 1% above that for June - announced in July."
As some are already stating as fact that inflation has peaked, this prediction would mean horrible things for asset markets if it came true. It also implies that the monetary policy must be steadfast and aggressive. Many people in markets now are hoping that the monetarists are wrong.

QT Matters

While everyone is braced for quantitative tightening, it doesn’t necessarily follow that it has already wrought all that it is going to wreak. Even if we know what’s coming, the practical impact of liquidity being removed from the system is yet to be felt. It is what the Fed does with its balance sheet at the margin that matters for asset prices, and there is little or no lag.

The following charts from Mike Howell of Crossborder Capital Ltd. in London demonstrate that the S&P 500 tends to react in real time to rises and falls in the balance sheet. The Fed has already made some liquidity reductions since the turn of the year, and they coincided more or less exactly with the beginning of the trouble for the stock market:

The risk of such accidents leaves many in the market still deeply skeptical that QT will happen as scheduled. This beautiful comment from the irrepressible Larry McDonald of Bear Traps Report LLC captures it neatly:"Hilarious - the Fed went to $50 billion a month in September of 2018 and had to stop five minutes later in December - this was after promising Wall St. economists they were on Auto-pilot all the way up to a $2 trillion reduction. Now, they are going to give it a try at $90 billion a month in May with back-to-back 50bp hikes? Who are they kidding? It´s the worst start to a year for stocks in decades, consumer savings is down to the bone, GDP prints negative, and the Fed is going to kick-off a record tightening cycle? It´s all a show. With conviction - we see a near-term top in the U.S. dollar and another leg up for hard assets, value vs. growth and emerging markets."
Lots of people feel the same way. QT is widely expected to start soon, but that doesn’t mean that all its effects have been felt, and it doesn’t mean that there is any confidence at all over what its effects will be. It remains the critical zone of uncertainty; what the Fed unveils this week will be critical in the battle against inflation, and in the attempt to avoid another financial accident.

Don’t Mention The War!

If it seems as though the conflict in Ukraine has somehow become yesterday’s story, there’s a reason for that. Looking at two good measures — global Google searches and total stories published by Bloomberg each day with the word “Ukraine” — interest in the subject has tanked:

Does this really make sense? Not to me it doesn’t. Recent news flow includes that Germany’s foreign minister doesn’t want to lift sanctions until Russia has fully withdrawn (including from Crimea), which implies they will be indefinite; supply chains have been seriously disrupted from Denmark to France; Russia now wants to move away from the dollar according to foreign minister Sergei Lavrov (who has also made highly inflammatory comments suggesting that Adolf Hitler was Jewish), there are signs that the war could spread to Moldova, President Biden is seeking to intensify U.S. military support, and escalation by the West, with unclear aims, grows ever more likely. And above all, President Putin is once again hinting unmistakably at the possible use of nuclear weapons.

The likelihood of a truly terrible outcome looks higher now to me (and I admit I’m certainly not a military strategist, but neither are the great majority of people responsible for managing money) than at any point in the last two months. At least as viewed from here, the Russian regime seems to be fraying, while the flow of senior politicians to Kyiv suggests the West is escalating with no clear objective, enchanted by the idea that it might be possible to inflict an outright defeat on Putin. For disquieting listening, I recommend this podcast with the New York Times’ veteran foreign affairs reporter David Sanger. For markets, there is still a lot of downside Ukrainian risk.

The last two years have provided an interesting experiment which could tell us whether Milton Friedman with the contention that inflation is always and everywhere a monetary issue. Money supply, more than anything else, in other words, drives prices been right all along. The British economist Tim Congdon, best known as one of the intellectual parents of “Thatcherite” economics in the 1980s, is confident that he is in the process of being proved correct. Exhibit a) might be that the economies that really opened the monetary spigots two years ago now have a serious inflation problem, and those that didn’t don’t. For a reminder, this is how money growth accelerated over the main pandemic period.The orthodox counterargument to this is that some nonmonetary factors have obviously moved inflation as well. The shift in spending from services to goods and the huge supply chain interruptions caused by Covid-19 and then by the war in Ukraine come to mind. But the monetarists can respond that there are still pockets of inflation unrelated to those factors. Congdon’s "The increases in house prices on the Federal Housing Finance Agency’s “purchase-only” index was 18.2% in the year to January. As yet, no meaningful cooling of the housing market has occurred, as the increase in the FHFA index in the three months to January was 4.1%, with an annualised rate of increase of 17.4%. Now comes the polemical point. It is plainly daft to attribute the remarkable increase in the price of houses - many of which were built a few decades ago - to energy prices, price movements in second-hand cars and lumber, the international shipping market and so on in 2020 and 2021. The correct interpretation is surely that rapid money growth sparked asset price inflation, which motivated a boom in aggregate demand, which took output far into over-heating territory, which led to soaring inflation in goods and services… Today’s supply shortages are a symptom of inflation, not a cause."

Nor will further urbanization ride to the rescue here. Officially, China has only a 64.7% urbanization rate, compared to over 80% in the U.S. You might think, therefore, that China has plenty of room to move people from farms to cities. But in fact, this is purely an artifact of how China defines urban population. In China, only people who live in cities with populations of larger than 100,000 are considered “urban”. In the U.S., that number is just 2500. So lots of China’s “rural” population isn’t even close to what Americans would consider “rural”. In fact, when economists try to estimate China’s “Lewis Turning Point” — the point where a country no longer has surplus agricultural population to shift into urban manufacturing industries — they agree that China either reached it a while ago, or is reaching it right about now.China’s productivity slowed down at a much lower income level than other East Asian countriesNow, as the experience of Taiwan, Korea, and Singapore show, it’s possible to dip and then recover, at least somewhat. But China’s productivity growth slowed so much earlier than that of its regional peers that even a modest re-acceleration would leave it significantly behind. In other words, just because China has “room” to catch up with the rich countries doesn’t mean it will.

Noah Smith, "Does China have hidden reservoirs of growth potential?,"Noahpinion, May 5, 2022, https://noahpinion.substack.com/p/does-china-have-hidden-reservoirs

Does China have hidden reservoirs of growth potential?

Within the last year, I’ve noticed a distinct souring on the topic of China’s growth prospects among the commentariat. This makes sense, of course. Between seemingly never-ending Covid lockdowns, a protracted crash in the vast real estate sector, Xi’s weird crackdown on internet companies, and the fear of Russia-like sanctions in the event of a conflict, there are now a lot more reasons to worry that China’s amazing catch-up growth story is drawing to an end. In fact, these new stumbles come on the heels of longer-term trends that have relentlessly pushed down China’s growth prospects — slowing productivity growth, reduced opportunities for copying Western technology, and rapidly aging demographics.

This is obviously an important question for multinational companies who are thinking about curbing or even abandoning their investments in China:

China witnessed $17.5 billion worth of portfolio outflows last month, an all-time high, according to most recent data from the Institute of International Finance (IIF). The US-based trade association called this capital flight by overseas investors "unprecedented," especially as there were no similar outflows from other emerging markets during this period. The outflows included $11.2 billion in bonds, while the rest were equities.

With so many reasons to leave, why stay? The answer is: Sheer market size. The most important reason to be invested in China switched long ago from cheap labor costs to market access. Even if the Chinese government takes various steps to limit foreign companies’ market access and support home-grown competitors, even a tiny sliver of a billion consumers equals vast riches. So obviously, the question of whether the Chinese market will continue to grow is an important factor for investors.

Despite the darkening outlook on the China growth question, pockets of optimism remain. Some of these come from the people I call “obligate longs” — people whose job it is, in essence, to reassure Western businesspeople that investing in China is safe and attractive. But some optimism comes from less directly interested parties — for example, from my fellow Substack blogger Adam Tooze, and from Bert Hofman of the National University of Singapore.

Demographics

One of their main arguments is that China’s demographic crisis is not nearly as severe as people think. For example, here is a slide from Hofman’s talk showing that if China were to simply raise its retirement age to 65, its labor woes would essentially vanish:

Color me very skeptical. Here are the UN’s projections for China’s population age 15-64:

But having seen firsthand the effects of forced early retirement in Japan (where the retirement age was 60 for many workers for a long time), I’m skeptical that a lot of these 61-year-olds are actually retired. Many of them probably go to work at much more low-paying jobs after being forced to quit their career job. They’re still in the labor force, they’re just not earning nearly as much. So the labor force bump from Hofman’s projection might be illusory.

It still might be true, of course, that keeping those folks in their career jobs for a few years longer will raise national productivity by a substantial amount. Old workers certainly have a big accumulated stock of knowledge about the companies and industries where they’ve worked for decades. But as Adam Ozimek suggested in a recent presentation, it’s also possible that doing this will cause Chinese companies to ossify — top-heavy with older management, these companies might fail to embrace new technologies and new business models. Ozimek’s own research shows a negative correlation between population aging and productivity:

In other words, productivity probably peaks at some point in a worker’s life. So keeping elderly managers in the top spots in China’s companies might not be the best idea for growth, whatever the official labor force numbers say.

Conversely, there’s the question of how many young workers China has. And we see that this number has already fallen by quite a lot:

So to sum up, China’s demographics probably are just as much of a headwind as everyone thinks they are.

Nor will further urbanization ride to the rescue here. Officially, China has only a 64.7% urbanization rate, compared to over 80% in the U.S. You might think, therefore, that China has plenty of room to move people from farms to cities. But in fact, this is purely an artifact of how China defines urban population. In China, only people who live in cities with populations of larger than 100,000 are considered “urban”. In the U.S., that number is just 2500. So lots of China’s “rural” population isn’t even close to what Americans would consider “rural”.

In fact, when economists try to estimate China’s “Lewis Turning Point” — the point where a country no longer has surplus agricultural population to shift into urban manufacturing industries — they agree that China either reached it a while ago, or is reaching it right about now.

Productivity

Tooze and Hofman emphasize the fact that China still has only a little over 1/4 the per capita GDP of the U.S., and so still seems to have plenty of “room to grow”. But there are a great many countries in the world that fail to grow fast despite having plenty of room. In the past, China has fulfilled its potential; in the future, this may change.

The key here is productivity. You can build a lot of physical capital, but once you’ve built a certain amount, how rich you are relative to top countries like the U.S. depends entirely on how efficiently you use your resources of labor and capital.

And here, China has not been looking so amazing in the last 15 years or so. The Lowy Institute has a long and highly informative article with a great section on productivity (which Tooze links to). Here’s one of their graphs:

Now, as the experience of Taiwan, Korea, and Singapore show, it’s possible to dip and then recover, at least somewhat. But China’s productivity growth slowed so much earlier than that of its regional peers that even a modest re-acceleration would leave it significantly behind.

So what’s the positive case for a productivity acceleration here? Tooze and Hofman tout the country’s rising tertiary (college) education levels:

Finally, Tooze touts Xi Jinping’s industrial policy, covered in depth in a recent Economist article. Basically, the idea here is that Xi is going to force China’s economy to divert resources away from industries like real estate, internet, and finance, and toward industries like semiconductors, artificial intelligence, robotics, electric vehicles, and the internet of things, and that this will result in big productivity gains.

In fact, I think it’s no exaggeration to say that this is the main hope for continued Chinese growth. But I also think that what Xi Jinping is trying to do is qualitatively different from the (occasionally successful) industrial policy drives that other countries have undertaken. He’s not just promoting the industries he likes; he’s trying to supercharge their growth by smashing the industries he doesn’t like. The idea seems to be that the economy’s industrial structure is like a tube of toothpaste, and if you squeeze one end, capital and labor and human ingenuity will spurt out the other end. Industrial policy is usually about picking winners; Xi wants to pick losers too.

I am skeptical that this will work. Sure, Xi can probably get a little mileage from pumping up the industries of the future (though even there it will depend on competence in execution, which is generally the exception rather than the norm). But I don’t think most of the untold millions of Chinese people who are forced to quit building and financing apartment buildings are going to start successful, innovative companies in AI and robotics. They just don’t know how to do that.

And I think Xi already sort of realizes that. Already, in the face of slowing growth, the government is trying to partially back away from its crackdown on internet companies. But at this point the damage has probably been done, not just to that industry but to entrepreneurship everywhere. It’s going to be harder, going forward, to get innovative entrepreneurship in any sector other than the ones Xi explicitly supports.

So while it’s conceivable that Xi will be able to pull off some totally novel industrial policy magic, the chances don’t look great — unless you’re one of those people who think that the Chinese government is just operating on another level from every other government that has ever existed, which is a thing that some people do think.

Anyway, to sum up, the continued bull case for Chinese growth rests to a large degree on optimistic assumptions about two things:

1. China’s ability to counteract extremely unfavorable demographics by having old people stay in their jobs longer, and
2. Xi Jinping’s ability to invent whole new and wildly successful forms of industrial policy.

I don’t think I quite buy this case just yet.

Twenty-eight percent of Democrats are now college-educated women, an increase from 12 percent in 1998. Men without any college education have increasingly identified as Republican, but by a less substantial degree. Men consistently report greater interest in discussing and paying attention to politics, even if they are slightly less like to vote in elections than women are. Seven in 10 (70 percent) men say they follow news about national politics somewhat or very closely, compared to 57 percent of women. More than four in 10 (42 percent) women, including 60 percent of young women, report that they do not really follow news about national politics. conceptions of sex and sexuality have also undergone drastic changes in recent years. Young people express increasing fluidity in feelings of physical attraction, but these generational differences are much more prevalent among women. Women are more likely than men to report physical attraction to both genders. This is by far most evident among young women. Just over half (56 percent) of women ages 18 to 29 say they are attracted to only men, compared to 83 percent of women ages 65 and older. There are massive gender differences in the consumption of pornography. Men are four times more likely than women to report having watched pornography in the past month (44 percent vs. 11 percent). Men in their 30s and 40s report the most frequent use of pornography A majority (57 percent) of men age 30-49 report having watched pornography in the past month, and 42 percent say they have watched it in the past week. In contrast, 44 percent of young men and only 26 percent of senior men say they have watched pornography at some point during the past month

Daniel A. Cox,Dana Popky and Beatrice Lee, "Politics, Sex, and Sexuality: The Growing Gender Divide in American Life," American Enterprise Institute, May 4, 2022, https://www.aei.org/research-products/report/politics-sex-and-sexuality-the-growing-gender-divide-in-american-life/

As a result, an assessment of a college’s performance would be more relevant, transparent, and likely to lead to improvement if it considered the performance of institutions enrolling comparable groups of at-risk students. To illustrate that the elephant in the room (demographics) is easy to see, I identified 444 public and 688 private, not-for-profit, primarily four-year colleges and universities for which the relevant data on wages and demographics were available These colleges were divided into quintiles based on average median earnings of students who are working 10 years after they first enrolled. The available data include all students, whether they graduated or dropped out and with no regard to the time they spent in school. To test how strongly demographics are correlated with postcollegiate earnings, four student groups likely to experience lower earnings were chosen: Black, Hispanic, low-income (whose federal Pell Grant eligibility serves as a proxy for socioeconomic status), and marginally prepared academically students (those facing a greater risk of not graduating). I also included a group that could be expected to experience higher earnings: students coming from households in the highest quintile of income distribution. Table 1 shows the results, with the selected demographic characteristics correlated with average median earnings that are reported for the institutions’ former students. As Table 1 makes evident, the percentage of Black students increases from the institutions with the highest earnings among former students to those with the lowest earnings. Likewise, for the percentage of Pell-eligible (i.e., low-income) students, the percentage increases as earnings decline. And the reverse takes place when observing overall graduation rates: The higher the earnings quintile that an institution is in, the higher the percentage of completers. In this case, limited to students in four-year schools, Hispanic students are primarily concentrated in states with high levels of wage inequality, which have been shown to correlate with high levels of social mobility for college-educated populations.6 Consequently, Hispanic students represent the inverse of what is found for Black students, although this phenomenon is likely not reflected for the two-year colleges many low-income Hispanic students attend

Jorge Klor de Alva, "Accounting for Demographics and Risk in Postcollege Earnings,"American Enterprise Institute, May 2022, https://www.aei.org/wp-content/uploads/2022/05/Accounting-for-Demographics-and-Risk-in-Postcollege-Earnings.pdf

Three times a year, millions of K-12 students in the U.S. take a test known as the MAP that measures their skills in math and reading. A team of researchers at Harvard’s Center for Education Policy Research have used the MAP’s results to study learning during a two-year period starting in the fall of 2019, before the pandemic began. The researchers broke the students into different groups based on how much time they had spent attending in-person school during 2020-21 — the academic year with the most variation in whether schools were open. On average, students who attended in-person school for nearly all of 2020-21 lost about 20 percent worth of a typical school year’s math learning during the study’s two-year window. Some of those losses stemmed from the time the students had spent learning remotely during the spring of 2020, when school buildings were almost universally closed. And some of the losses stemmed from the difficulties of in-person schooling during the pandemic, as families coped with disruption and illness. But students who stayed home for most of 2020-21 fared much worse. On average, they lost the equivalent of about 50 percent of a typical school year’s math learning during the study’s two-year window. Black and Latino students, fell further behind over the past two years, relative to students who are high-income, white or Asian.

David Leonhardt, ‘Not Good for Learning’, New York Times, May 5, 2022,
https://www.nytimes.com/2022/05/05/briefing/school-closures-covid-learning-loss.html

‘Not Good for Learning’

When Covid-19 began to sweep across the country in March 2020, schools in every state closed their doors. Remote instruction effectively became a national policy for the rest of that spring.

A few months later, however, school districts began to make different decisions about whether to reopen. Across much of the South and the Great Plains as well as some pockets of the Northeast, schools resumed in-person classes in the fall of 2020. Across much of the Northeast, Midwest and West Coast, school buildings stayed closed and classes remained online for months.

These differences created a huge experiment, testing how well remote learning worked during the pandemic. Academic researchers have since been studying the subject, and they have come to a consistent conclusion: Remote learning was a failure.

In today’s newsletter, I’ll cover that research as well as two related questions: How might the country help children make up the losses? And should schools have reopened earlier — or were the closures a crucial part of the country’s Covid response?

A generational loss

Three times a year, millions of K-12 students in the U.S. take a test known as the MAP that measures their skills in math and reading. A team of researchers at Harvard’s Center for Education Policy Research have used the MAP’s results to study learning during a two-year period starting in the fall of 2019, before the pandemic began.

The researchers broke the students into different groups based on how much time they had spent attending in-person school during 2020-21 — the academic year with the most variation in whether schools were open. On average, students who attended in-person school for nearly all of 2020-21 lost about 20 percent worth of a typical school year’s math learning during the study’s two-year window.

Some of those losses stemmed from the time the students had spent learning remotely during the spring of 2020, when school buildings were almost universally closed. And some of the losses stemmed from the difficulties of in-person schooling during the pandemic, as families coped with disruption and illness.

But students who stayed home for most of 2020-21 fared much worse. On average, they lost the equivalent of about 50 percent of a typical school year’s math learning during the study’s two-year window.

“We have seen from this recent study just how large the gaps are,” Roberto Rodríguez, an assistant secretary in President Biden’s Education Department, told me.

One of the most alarming findings is that school closures widened both economic and racial inequality in learning. In Monday’s newsletter, I told you about how much progress K-12 education had made in the U.S. during the 1990s and early 2000s: Math and reading skills improved, especially for Black and Latino students.

The Covid closures have reversed much of that progress, at least for now. Low-income students, as well as Black and Latino students, fell further behind over the past two years, relative to students who are high-income, white or Asian. “This will probably be the largest increase in educational inequity in a generation,” Thomas Kane, an author of the Harvard study, told me.

There are two main reasons. First, schools with large numbers of poor students were more likely to go remote.

Second, low-income students tended to fare even worse when schools went remote. They may not have had reliable internet access, a quiet room in which to work or a parent who could take time off from work to help solve problems.

A catch-up effort

Congress has tried to address the learning loss by allocating about $190 billion for schools in pandemic rescue bills. That amounts to more than $3,500 for the average K-12 student in public school.

Rodríguez, the Education Department official, said he was encouraged by how schools were using the money. One strategy with a documented track record is known as high-dosage tutoring, he noted. Sessions can involve three or four students, receiving at least a half-hour of targeted instruction a few times a week.

Kane is more worried about how schools are using the federal money. He thinks many are spending a significant chunk of it on nonacademic programs, like new technology. “I’m afraid that while school agencies are planning a range of activities for catch-up, their plans are just not commensurate with the losses,” he said.

By the time schools realize that many students remain far behind, the federal money may be gone.

What might have been

Were many of these problems avoidable? The evidence suggests that they were. Extended school closures appear to have done much more harm than good, and many school administrators probably could have recognized as much by the fall of 2020.

In places where schools reopened that summer and fall, the spread of Covid was not noticeably worse than in places where schools remained closed. Schools also reopened in parts of Europe without seeming to spark outbreaks.

In October 2020, Oster wrote a piece in The Atlantic headlined “Schools Aren’t Superspreaders,” and she told me this week that the evidence was pretty clear even earlier. By the fall of 2020, many people were no longer staying isolated in their homes, which meant that reopened schools did not create major new risks.

The Washington Post recently profiled a district in Colorado where schools reopened quickly, noting that no children were hospitalized and many thrived. “We wanted it to be as normal as possible,” Chris Taylor, the president of the school board, said.

Hundreds of other districts, especially in liberal communities, instead kept schools closed for a year or more. Officials said they were doing so to protect children and especially the most vulnerable children. The effect, however, was often the opposite.

Over the past two years, the U.S. has suffered two very different Covid problems. Many Americans have underreacted to the pandemic, refusing to take lifesaving vaccines. Many others have overreacted, overlooking the large and unequal costs of allowing Covid to dominate daily life for months on end.

The average Black student went to a district that spent $14,385 per student, while the average white student went to one that spent $14,263 per student. When the expenditures were narrowed to spending on instruction, the figures were $7,169 per student and $7,329 per student, respectively. Rather than looking at spending on an average student, they examined the relationship between per-student spending on instruction and the share of Black students in a district. The results are shown in the figure below. “There is a small but statistically significant negative relationship; on average, schools with a 10-percentage-point higher share of Black students spend $140 less per student on instruction…The data on total expenditures are similar; schools with a 10% higher share of Black students spend $160 less per student.”What explains this negative correlation when average spending is very similar? The scatter plot reveals significant variation in school spending and that districts spending the most tend to have a mostly white student body, the authors pointed out. Thus, this negative correlation is driven by small, predominantly white school districts with large spending that don’t educate a big share of the student body nationally

Hannah Rubinton and Maggie Isaacson, "Is There a Racial Gap in School District Spending?,"Federal Reserve Bank Of St. Louis, May 5, 2022, https://www.stlouisfed.org/on-the-economy/2022/may/racial-gap-school-district-spending

Is There a Racial Gap in School District Spending?

Efforts have been made to address the race gap in educational achievement by targeting public school funding. A recent Economic Synopses essay explored the relationship between school districts’ budget and the racial composition of their student bodies.

St. Louis Fed Economist Hannah Rubinton and Research Associate Maggie Isaacson analyzed the revenue and spending per student for school districts in the 2017-18 academic year, comparing the data for Black students and for white students.1

Spending Levels Were Similar, But Funding Sources Weren’t

The authors found that the numbers were very similar: The average Black student went to a district that spent $14,385 per student, while the average white student went to one that spent $14,263 per student. When the expenditures were narrowed to spending on instruction, the figures were $7,169 per student and $7,329 per student, respectively.

However, Rubinton and Isaacson noted that the funding sources were different. While states contributed 46% of funding for these school districts, regardless of the average student’s race, the average white student attended a district that received 47% of revenue from local sources and 7% from the federal government. For the average Black student, the district obtained 44% of revenue from local sources and 10% from the federal government.

“Because federal funding often comes as grants or for specific programs, school districts that serve predominantly Black student bodies may have less control over how these funds are spent,” they pointed out.

Instructional Spending Was Unequal

The authors then conducted a different analysis. Rather than looking at spending on an average student, they examined the relationship between per-student spending on instruction and the share of Black students in a district. The results are shown in the figure below.

What explains this negative correlation when average spending is very similar? The scatter plot reveals significant variation in school spending and that districts spending the most tend to have a mostly white student body, the authors pointed out. Thus, this negative correlation is driven by small, predominantly white school districts with large spending that don’t educate a big share of the student body nationally, Rubinton and Isaacson concluded.

Notes and References

The authors excluded districts in the top 1% and bottom 1% of spending per student; they also omitted the 1% of districts with the smallest numbers of students.

An estimated 1.5 million retirees have reentered the U.S. labor market over the past year, according to an analysis of Labor Department data by Nick Bunker, an economist at Indeed. That means the economy has made up most of the extra losses of retirees since February 2020, a Washington Post analysis shows. Roughly 2.4 million additional Americans retired in the 18 months of the pandemic than expected, making up the majority of the 4.2 million people who left the labor force between March 2020 and July 2021, according to Miguel Faria-e-Castro, a senior economist at the Federal Reserve Bank of St. Louis.

Abha Bhattarai, "Millions retired early during the pandemic. Many are now returning to work, new data shows,"Washington Post, May 5, 2022, https://www.washingtonpost.com/business/2022/05/05/retirement-jobs-work-inflation-medicare/

Millions retired early during the pandemic. Many are now returning to work, new data shows.

Millions of older Americans stopped working during the pandemic, far more than usual, stoking fears that the workforce had been permanently altered, but the country is close to closing the gap in early retirements, according to new data.

An estimated 1.5 million retirees have reentered the U.S. labor market over the past year, according to an analysis of Labor Department data by Nick Bunker, an economist at Indeed. That means the economy has made up most of the extra losses of retirees since February 2020, a Washington Post analysis shows.

Many retirees are being pulled back to jobs by a combination of diminishing covid concerns and more flexible work arrangements at a time when employers are desperate for workers. In some cases, workers say rising costs — and the inability to keep up while on a fixed income — are factoring heavily into their decisions as well.

Jerry Munoz recently returned to full-time work at a pharmaceutical company in San Diego after a decade of retirement. He’d gotten antsy staying home during the pandemic and said he felt safe going back into the office after receiving the coronavirus vaccine and booster. The extra pay from his new position as a safety consultant has been helpful, too: He and his wife recently bought an investment home with the money.

“Covid made me think about a lot of things and I felt like I was wasting my skills and my knowledge,” the 64-year-old said. “I told my wife that as long as I’m healthy enough, I’ll probably work another two years."

The percentage of retirees returning to work has picked up momentum in recent months, hitting a pandemic high of 3.2 percent in March, according to Indeed. In interviews with nearly a dozen workers who recently “un-retired," many said they felt comfortable returning to work now that they’ve gotten the coronavirus vaccine and booster shots. Almost all said they’d taken on jobs that were more accommodating of their needs, whether that meant being able to work remotely, travel less or set their own hours.

“This is primarily a story of a tight labor market,” said Bunker of Indeed, who added that there was a similar rebound in people returning from retirement after the Great Recession. “For so much of last year, the big question in the labor market was: Where are all the workers? This year we’re seeing that they’re coming back."

More employers are specifically recruiting retirees by posting jobs at senior centers and churches, as well as websites such as Retirementjobs.com and Workforce50.com aimed at older Americans. Many are also more willing to offer accommodations such as part-time or remote work, according to Amanda Cage, chief executive of the National Fund for Workforce Solutions.

“This is the first time I’ve seen retirees become a targeted population," she said. “It’s very different from what we saw in the last recession, when older workers faced extreme discrimination in the labor market in a way that they never quite recovered from.”

Robert Blethen, a retired truck driver in Connecticut, wasn’t exactly looking to work again. But the 70-year-old was lured back last fall when he got a call asking if he’d be willing to drive nine horses from Oklahoma to Maine.

That two-day gig turned into part-time work and eventually, full-time employment for a small trucking company. Now he’s on the road 72 hours a week shuttling livestock to and from Florida. Blethen, who receives about $2,800 a month in Social Security, says the extra money has helped cover home improvement costs, including a new heating system, garage doors and window installations.

“I was kind of bored, and the company was short of help,” said Blethen, who has been working since he was 12. “Plus I’m being compensated very well."

Although it’s clear that people are reentering the workforce at higher rates, it’s less clear exactly what sorts of jobs they’re getting — or how much of their decisions are voluntary, said Beth Truesdale, an expert in the aging workforce and inequality at the W.E. Upjohn Institute for Employment Research.

“The privilege of being able to retire early or to return to work if you want to, is restricted to a tiny, tiny fraction of Americans,” Truesdale said. “People are making choices under very constrained circumstances.... In many cases, it isn’t a choice to work longer so much as having to work longer to make ends meet."

Roblyn Melton, 58, a retired educator in Farmington, Mo., recently took a full-time job as a curriculum consultant because of astronomical health insurance premiums, which at $1,200 a month, were double her mortgage. She plans to work for another seven years until she’s eligible for Medicare.

“Basically I went back to work because of health insurance,” said Melton, who was retired for three years. “But I did pick a job that I enjoyed doing, so it’s not like I went back to do something I hate.”

Leaving the workforce early can be both a result and driver of inequality, economists say. More vulnerable older workers — in lower-wage jobs without college degrees — were most likely to stop working prematurely during the pandemic, while more privileged Americans tended to delay retirement, according to The New School’s Retirement Equity Lab. The share of Black workers without a college degree who stopped working before age 65 increased the most.

“At the beginning of the pandemic, an awful lot of older people were pushed out of jobs or left because of high health risks," Truesdale said. “What does it mean to retire under those circumstances? It can be very complicated.”

Determining exactly who is “retired" versus simply out of work can also be tricky, she said. Many people who leave the labor force in their 50s and early 60s do so because of health concerns or caregiving responsibilities, both of which were amplified early in the covid crisis. Others may leave early because of employee buyouts or early retirement packages, which tend to target the oldest workers.

Early in the pandemic, Scott Ward, then 57, took an early retirement offer from his job at a global tech firm in Silicon Valley. He wasn’t quite ready to stop working, but he said he had gotten tired of frequent international travel. With little else to do after leaving his job, the former human resources director signed up for virtual acting classes.

Now he’s reentered the workforce in two ways: as an HR manager at a small firm that requires much less travel, and as an actor in horror movies and romantic comedies. He has several gigs lined up this year, including one as a deputy sheriff in a werewolf movie and another as a lead in a fantasy adventure.

“I was kind of concerned that it would be hard to get back to work because of my age," said Ward, 59. “But given the market right now, it was easy."

Workers between the ages of 55 and 64 — who don’t tend to qualify for Medicare or full Social Security benefits — are among those most likely to return to the workforce, said Owen Davis, a research associate at the New School’s Schwartz Center for Economic Policy Analysis.

“Retirement is influenced by your wealth, your health and your job prospects — and those things can either move in the same direction, or they can all push in different ways,” he said.

Connie Kitchens retired in 2018 after three decades working in Georgia public schools, most recently as a middle school teacher. But now the 61-year-old says she’ll likely have to return to work, at least part-time, so her family can keep up with rising costs for food and health care.

She and her husband, a retired law enforcement officer, are raising two young grandchildren after their daughter died of breast cancer. They receive about $10,000 in Social Security and pensions every month, before taxes, although she said that’s not enough to live on for a family of four. They stopped going to restaurants and have cut back on weekend trips to visit family. Her monthly grocery bill has gone from $300 to nearly $600, in part because her grandson, who has sickle cell anemia, requires specialty items like Pediasure and lactose-free milk, often in short supply.

“The price of meat just shot all the way up — it’s so high that chicken costs as much as steak used to,” said Kitchens, who has been mulling a return to work but needs flexibility for her grandson’s medical appointments. “I have to find the right job, with flexibility. This isn’t what I dreamed it was going to be when I retired.”

Looking at American data going back to 1890 and British data from 1600 to 1914 Thomas Philippon finds that, when technological progress is properly understood, the world has been on broadly the same path for centuries. In the grand scheme of things, in other words, there has been no slowdown at all...according to Mr Philippon, is that tfp does not actually grow exponentially. Using the most popular data sources for long-term growth,he compares predictions from two different models to observed trends in tfp. A linear pattern—which he calls “additive growth”—consistently fits better with how progress has actually unfolded. Contrary to existing theories, that suggests previous research does not make the next idea any easier to find. It also explains why, as Mr Philippon puts it, some economists keep predicting some future wave of innovation that just never comes. While the rate of growth in percentage terms may be slowing, Mr Philippon’s model predicts that the size of any increment is roughly constant. Societies do get richer—but just not as fast as generally thought. evidence of moments when the rate of tfp growth does temporarily accelerate and the annual increment gets higher. His paper plots one such moment in Britain between 1650 and 1700, and another around 1830, consistent with when historians date the first and second Industrial Revolutions. He also finds one in America around 1930, which he credits to the adoption of electrification. Such moments only seem to take place about every century or so. But they do help to explain Mr Solow’s mistake: it would have been easy for him, as he was living through one of these periods of acceleration, to fall for the illusion of exponential progress.

Economist Staff, "Why long-term economic growth often disappoints,"The Economist, May 7, 2022, https://www.economist.com/finance-and-economics/2022/05/07/why-long-term-economic-growth-often-disappoints

Why long-term economic growth often disappoints

From the point of view of the 1950s, America’s economic progress over the 70 years that followed has been a huge disappointment. Futurists foresaw a world of super-pills, space farms and cities encased in glass. Science and technology would engineer unending riches and everything consumers could ever want. Yet the speed of gains achieved during the Space Age, it turned out, soon ebbed: between 2000 and 2019 America’s real income per head grew by 1.2% a year on average, down from 2% between 1980 and 1999 and 2.5% in the 1950s. And instead of flying cars, Peter Thiel, a venture capitalist, once jibed, “we got 140 characters”.

A new paper suggests such disappointment is not warranted—because it stems from an equally huge misunderstanding of how economic progress happens. Thomas Philippon, a professor of finance at New York University, argues the post-war experience was unusual. Looking at American data going back to 1890 and British data from 1600 to 1914 he finds that, when technological progress is properly understood, the world has been on broadly the same path for centuries. In the grand scheme of things, in other words, there has been no slowdown at all.

Most economists’ starting point for thinking about growth is Robert Solow’s 1956 paper, “A contribution to the theory of growth”. Mr Solow’s model for predicting a country’s long-term wealth relies on what he dubs the “production function”. It is a mathematical black box: on one side labour and capital go in; out the other come all the consumer goods and services that contribute to people’s standard of living. One way of growing is obvious: shove more labour and capital into the box. But that cannot deliver improvements for ever. Adding more labour means the output is divided between more workers. And capital wears out, so more investment is needed over time just to stay put.

Instead long-term growth can only come from improving the black box—the way in which labour and capital are combined. The fancy name economists give to this is total factor productivity (tfp), though they sometimes refer to it with more intuitive labels, such as technology or knowledge. You might think of it as a recipe. On one side lie labour and capital, the ingredients. On the other is the finished dish: economic output. tfp is an attempt to measure how effective the recipe is at combining the ingredients, which in turn depends on factors including the level of education on offer to the population, the quality of business management and the depth of scientific know-how.

Mr Solow assumed that the annual contribution of tfp to gdp would grow exponentially. This may have been for purely mathematical reasons: he wanted his model economy to grow at a fixed rate, of say 2% a year, which required ever larger gains as gdp got bigger to keep the pace of growth constant. Later economists, including Paul Romer (like Mr Solow, a Nobel prizewinner), have tried to work out the chemistry underpinning tfp’s presumed exponential growth. Their theories usually contend that some investment goes not into capital, but into research and development. And because knowledge can be freely copied, they observe, this investment has an increasing marginal product, meaning that each prior bit of research makes the next bit of research more effective. Knowledge thus cascades out, creating more knowledge as it does, akin to how a virus spreads in the early stage of an epidemic.

The problem, according to Mr Philippon, is that tfp does not actually grow exponentially. Using the most popular data sources for long-term growth, he compares predictions from two different models to observed trends in tfp. A linear pattern—which he calls “additive growth”—consistently fits better with how progress has actually unfolded. Contrary to existing theories, that suggests previous research does not make the next idea any easier to find. It also explains why, as Mr Philippon puts it, some economists keep predicting some future wave of innovation that just never comes.

This is not a counsel of despair. While the rate of growth in percentage terms may be slowing, Mr Philippon’s model predicts that the size of any increment is roughly constant. Societies do get richer—but just not as fast as generally thought.

Encouragingly, Mr Philippon also finds evidence of moments when the rate of tfp growth does temporarily accelerate and the annual increment gets higher. His paper plots one such moment in Britain between 1650 and 1700, and another around 1830, consistent with when historians date the first and second Industrial Revolutions. He also finds one in America around 1930, which he credits to the adoption of electrification. Such moments only seem to take place about every century or so. But they do help to explain Mr Solow’s mistake: it would have been easy for him, as he was living through one of these periods of acceleration, to fall for the illusion of exponential progress.

The ways of growth are inscrutable

Mr Philippon’s statistical analysis does not speak to tfp’s deeper conceptual problems. One is that capital is hard to value. There is usually a difference between its historical cost, suitably depreciated, and the discounted value of the profits it will eventually produce. Unlike labour, which can be quantified in hours, there is no non-monetary unit with which to value oil rigs and pharmaceutical patents alike. After Mr Solow’s 1956 paper came out, a group of economists at the University of Cambridge showed that its method for valuing capital was circular, a point Mr Solow’s followers conceded. But the model is still widely used regardless.

Similar problems bedevil tfp itself. Statistical techniques that try to measure the concept of “knowledge” typically bundle all the variation in growth that cannot be explained by changes in the workforce or investment into the black box. Hence tfp’s other, less flattering name—the “Solow residual”. Rather than a reliable metric of society’s level of knowledge, tfp so far seems to remain, in the words of a Solow critic, a “measure of our ignorance”.

The Economic Policy Institute had a very useful analysis of this data just before the pandemic. Between 1979 and 2000, there was a rough match between growth in one measure of overall inequality — the gap between wages at the 95th percentile and those of the median worker — and its estimate of the average wage premium for college-educated workers. Since 2000, however, wage inequality has continued to rise, while the college premium has barely changed... my own version of this observation, comparing growth of incomes of households at the 95th percentile with those of the median male college graduate. Now, Americans at the 95th percentile don’t consider themselves rich, because they aren’t, surely as compared with C.E.O.s, hedge funders and so on. Nonetheless, they have seen substantial gains. On the other hand, the typical college graduate — who is, remember, someone who made it through and received an accredited degree — hasn’t.

Paul Krugman, "Education Has Less to Do With Inequality Than You Think,"Krugman Wonks Out, April 29, 2022, https://www.nytimes.com/2022/04/29/opinion/college-student-loan-debt.html

Education Has Less to Do With Inequality Than You Think

President Biden says that he is taking a “hard look” at student debt relief, which probably means that some significant relief is coming. For one thing, Biden promised relief during the 2020 campaign. For another, it’s one progressive priority he can address by executive action, which is important given the extreme difficulty of getting anything through an evenly divided Senate.

How much relief will he offer? I have no idea. How much relief should he offer? I’m for going as big as political realities allow, but I understand that too generous a debt write-off might produce a backlash. And I have no confidence that I know where the line should be drawn.

What I think I do know is that much of the backlash to proposals for student debt relief is based on a false premise: the belief that Americans who have gone to college are, in general, members of the economic elite.

The falsity of this proposition is obvious for those who were exploited by predatory for-profit institutions that encouraged them to go into debt to get more or less worthless credentials. The same applies to those who took on educational debt but never managed to get a degree — not a small group. In fact, around 40 percent of student loan borrowers never finish their education.

But even among those who make it through, a college degree is hardly a guarantee of economic success. And I’m not sure how widely that reality is understood.

What is widely understood is that America has become a far more unequal society over the past 40 years or so. The nature of rising inequality, however, isn’t as broadly known. I keep encountering seemingly well-informed people who believe that we’re mainly looking at a widening gap between the college-educated and everyone else.

This story had some truth to it in the 1980s and 1990s, although even then it didn’t account for the huge income gains at the top of the distribution — the rise of the 1 percent and even more among the 0.01 percent. Since 2000, however, most college graduates have actually seen their real incomes stagnate or even decline.

The Economic Policy Institute had a very useful analysis of this data just before the pandemic. Between 1979 and 2000, there was a rough match between growth in one measure of overall inequality — the gap between wages at the 95th percentile and those of the median worker — and its estimate of the average wage premium for college-educated workers. Since 2000, however, wage inequality has continued to rise, while the college premium has barely changed:

So here’s how I see it: Much of the student debt weighing down millions of Americans can be attributed to false promises.

Some of these promises were scams pure and simple; think Trump University. Even those who weren’t outright cheated, however, were pulled in by elite messaging assuring them that a college degree was a ticket to financial success. Too many didn’t realize that their life circumstances might make it impossible to finish their education — it’s hard for comfortable, upper-middle-class Americans to realize how difficult staying in school can be for young people from poorer families with unstable incomes. Many of those who did manage to finish found that the financial rewards were far smaller than they expected.

And all too many of those who fell victim to these false promises ended up saddled with large debts.

Of course, there are many Americans who have suffered from rising inequality. I wouldn’t argue that college debtors are greater victims than, say, truck drivers who have seen their real wages plunge or families stuck in declining rural areas and small towns. And we should be helping all of these people.

Unfortunately, most things we could and should be doing for Americans in need — like extending the expanded child tax credit — can’t be done in the face of 50 Republican senators, plus Joe Manchin. Student debt relief, by contrast, is something President Biden can do. So he should.

The NY Fed released the Q1 Quarterly Report on Household Debt and Credit this morning. Look at the difference in credit scores in the recent period compared to the during the bubble years (2003 through 2006). Recently there have been almost no originations for borrowers with credit scores below 620, and few below 660. A significant majority of recent originations have been to borrowers with credit score above 760. Although originations increased recently for all age groups, there was a large increase for the 30-39 age group. This is the prime first-time homebuyer cohort - and is what was expected based on demographics. mortgage debt, as a percent of GDP, has been declining even as house prices have soared. Even if we see house prices decline in some areas, there will be very few forced sales since most borrowers have high credit score and significant equity in their homes - so we will not see cascading price declines as happened during the housing bust.

Bill McBride, "Mortgage Originations by Credit Score and Age,"Calculated Risk, May 10, 2022, https://calculatedrisk.substack.com/p/mortgage-originations-by-credit-score

Mortgage Originations by Credit Score and Age

The NY Fed released the Q1 Quarterly Report on Household Debt and Credit this morning. Here are a couple of charts from the report.

The first graph shows mortgage originations by credit score (this includes both purchase and refinance). Look at the difference in credit scores in the recent period compared to the during the bubble years (2003 through 2006). Recently there have been almost no originations for borrowers with credit scores below 620, and few below 660. A significant majority of recent originations have been to borrowers with credit score above 760.

Solid underwriting is a key reason I’ve argued Don't Compare the Current Housing Boom to the Bubble and Bust, Look instead at the 1978 to 1982 period for lessons

Mortgage Originations by Age

The second graph shows mortgage originations by age (this includes both purchase and refinance originations). Although originations increased recently for all age groups, there was a large increase for the 30-39 age group. This is the prime first-time homebuyer cohort - and is what was expected based on demographics.

The NY Fed Liberty Street Economist has a new blog post today: Refinance Boom Winds Down. This is a key paragraph (see post for some interesting graphs):The memory of the last housing boom and bust remains a troubling reminder for many Americans as home prices soar. The collapse of the housing market left significant financial scars on households-millions of whom were left owing more on their properties than they were worth, and with more than 10 million Americans experiencing a foreclosure.But there are many differences in the mortgage market now compared to 2007. First, unlike the 2003-06 housing boom, mortgage debt has been rising much more slowly than home values.As above, the number of mortgages originated remains far lower than in the early part of our time series, which would be even lower if population adjusted. And finally- loans being originated now are going to higher credit score borrowers; more than 70 percent of mortgages originated in the last two years were to borrowers with credit scores over 760, compared to 38 percent between 2003-06.Subprime mortgages remain effectively non-existent. With house prices continuing to rise and housing affordability a growing concern, there remain risks, and we will continue to monitor the evolution of the housing and mortgage market.

emphasis added

The last graph is based on data from the Fed’s Q1 Financial Accounts of the United States. This shows that mortgage debt, as a percent of GDP, has been declining even as house prices have soared. Even if we see house prices decline in some areas, there will be very few forced sales since most borrowers have high credit score and significant equity in their homes - so we will not see cascading price declines as happened during the housing bust.

Directed by a consolidated government budget constraint, we compare US monetary-fiscal responses to World Wars I and II and the War on COVID-19. How did the government pay for these outlays?For World War I, the answer is: 20.8% taxes, 74.3% growth in interest-bearing debt, 6.9% money growth, and -2.0% from the remaining terms. For World War II, the answer is: 30.2% taxes, 46.0% growth in interest-bearing debt, 10.1% money growth, and 13.7% from the remaining terms. For the War on COVID-19, so far, the federal government has spent slightly over 1/5 of a year’s GDP to fight COVID-19. Relative to the size of the economy, the US government has already spent a little more than half of what it spent fighting World War I. On top of these outlays, the Federal Reserve has increased its holding of private assets, largely mortgage-backed securities, by 5.85% of a year’s GDP. For COVID-19, we decompose revenues in two ways. In our first decomposition, we count reserve balances at the Federal Reserve as part of base money. In this case, the revenue decomposition is: 3.5% taxes, -2.2% growth in interest-bearing debt, 91.7% money growth, and 7.0% from the remaining terms. Our second decomposition acknowledges that the Federal Reserve has paid interest on reserve deposits since 2008 and issued more reverse repurchase agreements. When we count these reserves and reverse repos as interest-bearing federal debt and subtract them from our measure of Fed credit, the revenue decomposition for the COVID-19 War becomes: 3.5% taxes, 67.0% growth in interest-bearing debt, 18.5% money growth, and 11.1% from the remaining terms.It is striking how little of the War on COVID-19 has thus far been financed by explicit taxation, even compared to World Wars I and II

Good Keynes observation, “What a Government spends the public pay for. There is no such thing as an uncovered deficit.But in some countries, it seems possible to please and content the public, for a time at least, by giving them in return for the taxes that they pay, finely engraved acknowledgements on water-marked paper. The income tax receipts, which we in England receive from the surveyor, we throw into the waste paper basket; in Germany they call them bank-notes and put them into their pocketbooks; in France they are termed Rentes and are locked up in the family safe.”
-John Maynard Keynes, 1923, A Tract on Monetary Reform,pp. 62.

“…we decompose wartime increases in federal revenue by computing deviations from peacetime baselines values for each term in equation (2) and summing these deviations between the start and the end of each war. We describe this decomposition in
section 1 of the appendix. Columns 1, 2, and 3 of table 2 report spending from the left side of equation (2). Columns 5 and 6 report wartime changes in tax revenues and debt relative to prewar baselines. Columns 7-9 report wartime changes in money growth, real GDP growth, and inflation. Column 10 reports the sum of changes in other means, the cross product, and a sum of residuals.12 For each war, entries in the first row are percent’s of GDP and we sum over years. Entries in columns 5-10 sum to column 4; for example, the increase in government spending for World War I over the two years 1917-1918 was 36.93% of a single year's GDP. Net payouts to bondholders during the war were 0.30% of a year's GDP, and the Fed purchased private assets worth 0.16% of a year's GDP bringing the total cost of the war to 37.39%. The numbers in the second row are percentages of the sum of war-related government spending, net payouts to bondholders and asset purchases (column 4) accounted for by each term on the right side of equation (2)….”

"...From 1919 to 1928, driven largely by primary surpluses and real GDP growth, the debt-GDP ratio fell from 28.6 to 20.2; but then from 1929 to 1934 as real GDP growth became negative and the federal government began to run primary de cits, the debt-GDP ratio rose to 31.4. From 1945 to 1960, the debt-GDP ratio fell from 90.1 to 35.7. That reduction was attributable to inflation (71%), real GDP growth (29%), and primary surpluses (24%). These add to more than 100% because, offsetting these contributions, bondholders received 26% of the 54.4% decrease in the debt-GDP ratio. Figure 9 visualizes how the table 3 decompositions accumulated gradually over 15 year time spans...."

George Hall and Thomas Sargent, "Three World Wars: Fiscal-Monetary Consequences,"Working Paper, April 4, 2022, http://www.tomsargent.com/research/Three_Wars.pdf

America is increasingly falling behind its peer nations. In the 1990s, America was a leader in employment levels thanks to its strong economy and relative accessibility to working women. The 2001 recession and the “jobless recovery” that followed knocked America back down to a level more in line with its peer nations—and then the 2008 recession knocked America far behind. Today, Italy—a nation notorious for its perennially broken labor market—is the only member of the G7 with lower prime age employment levels. Countries like Portugal and Japan—which have by no means experienced surges of dynamism or explosive economic growth over the last two decades—have managed to beat out the US and achieve 85% prime age employment rates. Male employment has been declining across advanced economies as men spend more time raising children and employment transitions away from traditionally male-dominated industries like manufacturing. Still, in few countries has the decline been as stark and as dramatic as in the US. Male prime-age employment rates in the US were nearly 10% off all-time-highs in 2009, and still remain 5% below their high-water mark.the majority of flows into employment every month do not come from unemployment but rather from outside the labor force.This is true during all but the very worst recessions (i.e., early 2020), butduring boom times nearly 3/4 of all flows into employment come from outside the labor force. Granted, that’s partially because the number of Americans outside the labor force is just so large (about 100 million people compared to about five million people in unemployment), but it also reveals how rapid growth in employment numbers can occur despite low unemployment numbers. American economic policymaking and punditry has a horrible history of presuming that workers outside the labor force are lost forever. In the 2010s drops in employment for non-college educated people were blamed on a “skills gap”. Drops in employment for young people were blamed on their laziness. Drops in employment for men were blamed on video games. By the late 2010s employment rates had basically recovered to pre-recession levels for all of these groups, proving that it was artificially weak labor demand keeping them out of the workforce.

Joseph Politano, "We Have a Chance to End America's Great Employment Failure,"Apricitas Economics, May 7, 2022, https://apricitas.substack.com/p/we-have-a-chance-to-end-americas

We Have a Chance to End America's Great Employment Failure

Regular readers of Apricitas will know that I focus heavily on the labor market as both an indicator for the state of the US economy and a goal for policymakers to influence. I believe—with good reason—that wages, work, and employment are the most important parts of economic well-being. The labor market is the market of markets—businesses depend on labor for basic function, workers depend on labor income for their consumption, investments require labor to make them valuable, and governments require labor to ensure the functioning of the state. Nearly every firm and household must, at some point, engage with the labor market. So much of prosperity at an individual and household level comes down to your employment, job security, and wages. Indeed, the most powerful countries in the modern world are not the ones with the largest natural resource reserves or the biggest armies but those with the best and most productive workforces.

That is why the last 25 years have been modern history’s biggest tragedy. A series of poor macroeconomic policy choices have resulted in decades of shrinking employment and lost wages across many high income countries—but especially in America. During the late 1990s, America’s labor market was arguably the strongest in the world. The 2001 and 2008 recessions left it permanently scarred—and now America significantly lags many of its peer countries.

For the sake of America’s workers, it must lead again.

America’s Great Employment Failure

Fundamentally, America lacks the institutionalized employment protections that many high-income nations have. When the pandemic struck, countries across Europe used the government’s tab to institute furlough and job retention schemes to keep workers in place despite the economic slowdown. The US has no such capabilities (hence the scramble to implement enhanced unemployment benefits at the start of the pandemic). The end result is that recessions in the US manifest as massive declines in the workforce. Couple that with the relatively weak policy responses to the 2001 and 2008 recessions and you have a situation where labor demand and employment remain artificially low for more than two decades. The good news is that the COVID recession saw by far the strongest and swiftest policy response in American history, allowing employment to recover to pre-pandemic levels in two short years. Still, there are millions of people who could be brought into employment in the next stage of the economic expansion. It will be to America’s great benefit if these people are brought into the workforce.

Idle Hands

Not have a job
Have actively looked for work in the last four weeks
and be currently available for work

Unsurprisingly these qualifications mean that many people who want to work are not counted as unemployed. About five million people are not in the labor force but say they want a job today, and these people are not counted as officially unemployed even though by any colloquial definition they would be considered unemployed. That’s another massive pool of possible workers that could be drawn into employment if labor demand remains strong.

American economic policymaking and punditry has a horrible history of presuming that workers outside the labor force are lost forever. In the 2010s drops in employment for non-college educated people were blamed on a “skills gap”. Drops in employment for young people were blamed on their laziness. Drops in employment for men were blamed on video games. By the late 2010s employment rates had basically recovered to pre-recession levels for all of these groups, proving that it was artificially weak labor demand keeping them out of the workforce. When companies increased their hiring intensity and wages began rising, many of these workers were drawn back into employment. During the pandemic we saw a microcosm of this regarding workers who were pushed into early retirement due to COVID. Policymakers and forecasters worried that these workers were out of the labor market for good, but as COVID abated and labor demand recovered many of these workers have since reentered the workforce. We shouldn’t discount the possibility of future employment gains just because those workers would come from outside the labor force instead of unemployment.

What Could You Do With An Extra $9,600 a Year?

In 2019 Americans earned, on average, about $9,600 less than they would have if growth had continued at the pre-Great Recession pace. Matt Klein puts it best: “Americans have been living below their means—producing, consuming, and investing less than they otherwise could have—for 15 years.” Much of that drop in earnings came from an inability or unwillingness from policymakers in Congress and the Federal Reserve to pursue the kind of aggressively stimulative monetary and fiscal policies that caused the post-COVID employment recovery to be so rapid. Think about all the buildings that went unbuilt, the skills that went undeveloped, and the inventions that went uninvented because America chose to idle tens of millions of workers—its most valuable resources—for decades.

Inflation has, understandably, taken center stage in today’s macroeconomic policy debate. As the Federal Reserve tightens monetary policy to reduce inflation, it is likely that the rate of employment growth will also slow. Truth be told, the rate of employment growth was always bound to slow at this point simply because the vast majority of previously-employed people have returned to work. The key remains to balance the need to combat inflation with the need to expand and strengthen America’s workforce. We have an opportunity to end America’s decades long employment failure, and it’s an opportunity we simply can’t afford to pass up.

Even though the unemployment rate is barely higher than the 50-year low of 3.5% it registered in February 2020, just before the Covid-19 crisis struck, there were 1.2 million fewer jobs than there were back then. Throw in population growth and the shortfall from prepandemic levels is even larger. The labor-force participation rate—the share of workers with a job or actively looking for one—was 62.2% last month versus 63.4% in February 2020.

Justin Lahart, "The U.S. Economy Is Desperately Seeking Workers,"Wall Street Journal, May 6, 2022, https://www.wsj.com/articles/desperately-seeking-workers-11651851566

The U.S. Economy Is Desperately Seeking Workers

There are two ways for the job market to cool off. One is for hiring to slow considerably. The other is for more people to enter the labor force. The latter is obviously preferable, but it isn’t clear how much of the latter the U.S. is going to get.

The Labor Department on Friday reported that the economy added a seasonally adjusted 428,000 jobs in April—equal with March’s gain and showing employment is growing at a heady clip. The unemployment rate, which is based off a separate survey, held at a very low 3.6%.

What would help the situation a lot is for more people to come back into the workforce. Even though the unemployment rate is barely higher than the 50-year low of 3.5% it registered in February 2020, just before the Covid-19 crisis struck, there were 1.2 million fewer jobs than there were back then. Throw in population growth and the shortfall from prepandemic levels is even larger.

The reason the unemployment rate is low despite reduced employment levels is that, to be counted as unemployed, one must be actively seeking work. A lot of people aren’t doing that. The labor-force participation rate—the share of workers with a job or actively looking for one—was 62.2% last month versus 63.4% in February 2020. That is, of course, much better than it was during the worst of the pandemic, but a lot of the things that seemed like they might draw even more people back into the labor force, such as the availability of vaccines, the easing of Covid-19 concerns and the ending of extra benefits for the unemployed, didn’t have as much of an effect as economists hoped.

Maybe with the advent of warmer weather, the continued easing of Covid-19 worries and the stockpiles of savings many Americans built up during the pandemic starting to diminish, more people will go on the job hunt. That is certainly what the Fed is looking for: In his press conference Wednesday following the Fed’s meeting, Chairman Jerome Powell said that he and other members of the central bank’s rate-setting committee “generally expect that we’ll get some additional participation.”

If that increase doesn’t come, however, the Fed will be put in a position where it will feel it needs to bring job growth down sooner rather than later. To do that, it will need to lift rates more quickly, raising the odds that it goes too far and sends the economy into a recession.

In March, the Labor Department reported that total factor productivity, or TFP, in the private nonfarm business sector increased 3.2 percent in 2021. That was the largest growth since 1983.The below chart comes from the San Francisco Fed, and includes a modified TFP measure that attempts to smooth out business cycle noisiness.

James Pethokoukis, "Good News, Bad News on US Productivity Growth,"American Enterprise Institute, May 6, 2022, https://www.aei.org/economics/good-news-bad-news-on-us-productivity-growth/

Good News, Bad News on US Productivity Growth

I only wish US productivity growth were as consistently strong as job growth. (The economy added 428,000 jobs in April, making it 12 consecutive months of employers adding at least 400,000 new jobs.) On Thursday, the Labor Department reported that non-farm business productivity fell at a 7.5 percent annualized pace, the sharpest quarterly decline in 75 years. “The mother of all productivity declines,” is how Capital Economics described it.

Of course, productivity numbers are famously volatile, and that seems to be especially true during this pandemic era. Then again, it’s not the first lousy number. From a CE research note:is now up only 2.6% since the fourth quarter of 2019, which translates into an annualized pace of little more than 1%. Pandemic-related shifts like working from home and increased capex provided no meaningful boost to labor productivity.
And here’s JPMorgan’s take (bold by me):Nonfarm productivity dropped 7.5% saar in 1Q on the combination of a 2.4% decline in output and a 5.5% increase in hours worked. Unit labor costs, meanwhile, surged 11.6% saar in 1Q.These 1Q figures were very close to our expectations, but the productivity reading disappointed the consensusand the unit labor costs figure beat the consensus forecast.The data can be choppy, and the 1Q swings likely are not fully indicative of the underlying trend. But as the recovery continues and the labor market keeps tightening, we think that the trend in productivity will moderateand the trend in unit labor costs will firm and these expectations have been broadly playing out through some of the noise in the quarterly readings.

And not all the news is bad. In March, the Labor Department reported that total factor productivity, or TFP, in the private nonfarm business sector increased 3.2 percent in 2021. That was the largest growth since 1983. (TFP is that part of economic growth that can’t be explained by production inputs, such as the number of hours worked or the amount of capital used. This unexplained bit presumably reflects advances in production technologies and processes.) The below chart comes from the San Francisco Fed, and includes a modified TFP measure that attempts to smooth out business cycle noisiness.

A common story about the recent inflation surge in the United States--especially among members of Team Transitory--is that the surge is largely due to global supply shocks, such as rising energy prices, chip shortages, and various bottlenecks in the wake of the worldwide pandemic. Why then do we not see a similar inflation surge in Japan? There, inflation is running at about the same rate as it was pre-pandemic. See below. I am puzzled.

Greg Mankiw, "An Inflation Puzzle,"Greg Mankiw's Blog, May 6, 2022, http://gregmankiw.blogspot.com/2022/05/an-inflation-puzzle.html

A common story about the recent inflation surge in the United States--especially among members of Team Transitory--is that the surge is largely due to global supply shocks, such as rising energy prices, chip shortages, and various bottlenecks in the wake of the worldwide pandemic. Why then do we not see a similar inflation surge in Japan? There, inflation is running at about the same rate as it was pre-pandemic. See below. (Click on image to enlarge.) I am puzzled.

Inflation exceeds average hourly earnings in the aggregate (private sector) and for Leisure and Hospitality Services (production and nonsupervisory). But they are still ahead of 2020M02 levels. Note that Cleveland Fed April CPI nowcast is 0.28% m/m, compared to Bloomberg consensus 0.2%. If Wednesday’s release exceeds 0.28%, then real average hourly earnings might decline again. While both real wage series are higher than pre-2020M03 (not holding composition constant), it’s interesting to note that leisure and hospitality services earnings are above 2016-19 trend. A caveat: My comparison is pre- vs. during pandemic, and using the CPI as a representative cost-of-living indicator. As noted by Rampell/WaPo, over the past year (2020Q4-2021Q4), the cost-of-living for low income households has risen more than for high income households. That’s consistent with the fact that the CPI is a plutocratic index, representing consumption weights for households at about the 75th percentile. Using a CPI calibrated to say the 20th percentile might change results noticeably.

Menzie Chinn, "Inflation Adjusted Wages since the Pandemic,"Econbrowser, May 8, 2022, https://econbrowser.com/archives/2022/05/inflation-adjusted-wages-since-the-pandemic

Inflation Adjusted Wages since the Pandemic

Inflation exceeds average hourly earnings in the aggregate (private sector) and for Leisure and Hospitality Services (production and nonsupervisory). But they are still ahead of 2020M02 levels.

While both real wage series are higher than pre-2020M03 (not holding composition constant), it’s interesting to note that leisure and hospitality services earnings are above 2016-19 trend.

Greg Mankiw, "Government Debt And Capital Accumulation In An Era Of Low Interest Rates,"National Bureau Of Economic Research, May 2022, https://scholar.harvard.edu/files/mankiw/files/government_debt_and_capital_accumulation_may2022_updated.pdf

Uptick in Savings Rate

“…The world saving rate averaged 25.1 percent during the latter half of this period, compared with 22.2 percent during the first half. An increase in the saving rate of 2.9 percentage points can explain a decline in the real interest rate of about 133 basis points…”

Decline In Growth

“…Another development, however, is more important. The rate of growth, represented in the Solow model by n + g, has declined in recent years, in part due to lower population growth and in part due to lower productivity growth. A decline in the growth rate of one percentage point reduces the real interest rate by 139 basis points. This effect goes a long way toward explaining the decline in interest rates. The World Bank reports data on world GDP growth from 1961 to 2020, shown in this figure World GDP growth averaged 2.8 percent per year in the most recent three decades, compared with 4.1 percent per year in the previous three—a fall of 1.3 percentage points. A change of this magnitude can explain a decline in real interest rates of about 181 basis points….”

Adding Market Power

“..An increase in the markup of 1 percentage point reduces the real interest rate by 8 basis points. Some of the literature suggests that markups have increased by 20 percentage points or more. This change could explain a decline in real interest rates of about 160 basis points….”

Implications For Fiscal Policy

“…The bottom line from the Diamond model is that the comparison of the real interest rate and the growth rate is crucial (as indeed it is in the Solow model). If the interest rate is less than the growth rate, as seems to be the case today, the economy is in a dynamically inefficient equilibrium. That is, it is saving so much that the capital stock exceeds the level that maximizes steady-state consumption. (Phelps, 1961, dubbed this the Golden Rule level of capital.) In this case, the government can run a sustainable Ponzi scheme by issuing debt and rolling it over, along with the accumulating interest, forever.6 To be sure, the government debt will absorb saving and crowd out capital, but that is a good thing because the economy has too much of it. Government debt can raise welfare when the debt is issued, in the steady state, and along the entire transition path.... Third, if the government in a dynamically efficient economy observes a safe rate much below the average growth rate and tries to run a Ponzi scheme by issuing a lot of debt and rolling it over forever, it is gambling. The policy may well work, but it might not. And the circumstances in which it fails are particularly dire. The big losers are the generations alive when the scheme fails, who must endure either a debt default or higher taxes. The failure is especially painful because it occurs in a state of world with extraordinarily low growth and thus high marginal utility of consumption. A government running a Ponzi scheme with debt is like a homeowner canceling his fire insurance to save money or an investor selling deep out-of-the-money puts: It works most of the time, but when it doesn’t, all hell breaks loose…”

Like many economists, I have been pondering the causes of the decline in real interest rates and its implications for fiscal policy. I don’t pretend to have all the answers. But this brief essay offers a progress report on my thinking The World Bank reports data on the world gross saving rate (as a percent of GNI) from 1975 to 2020. It shows a clear upward trend, as seen in the following figure The world saving rate averaged 25.1 percent during the latter half of this period, compared with 22.2 percent during the first half. An increase in the saving rate of 2.9 percentage points can explain a decline in the real interest rate of about 133 basis points Another development, however, is more important. The rate of growth, represented in the Solow model by n + g, has declined in recent years, in part due to lower population growth and in part due to lower productivity growth. A decline in the growth rate of one percentage point reduces the real interest rate by 139 basis points. This effect goes a long way toward explaining the decline in interest rates. The World Bank reports data on world GDP growth from 1961 to 2020, shown in this figure: World GDP growth averaged 2.8 percent per year in the most recent three decades, compared with 4.1 percent per year in the previous three—a fall of 1.3 percentage points. A change of this magnitude can explain a decline in real interest rates of about 181 basis points. These calculations lead me to conclude that the decline in the real interest rate over the past few decades is not all that mysterious.Based on just the textbook Solow model, the observed higher saving and lower growth rates can together explain a decline in the real interest rate of more than 3 percentage points, which is in the ballpark of what has occurred. What does a low interest rate mean for fiscal policy? If the interest rate is less than the growth rate, as seems to be the case today, the economy is in a dynamically inefficient equilibrium. That is, it is saving so much that the capital stock exceeds the level that maximizes steady-state consumption The calibrated Solow model gives a real interest rate of about 6 percent. No plausible set of parameters gives an interest rate less than zero, as we are now observing for long-term inflation adjusted bonds. Something must be missing from the model. In fact, two things are missing: risk and market power. An increase in the risk premium can drive down the safe interest rate, and it is possible that a rising risk premium can help explain the observed decline in real interest rates. Gauging this effect is difficult because changes in risk premiums are hard to measure. But I doubt that a rising risk premium is an important part of the story. Stock market valuations, such as price-earnings ratios, have risen while real interest rates have fallen, suggesting that the expected return on risky assets has fallen as well. My best guess is that a rising risk premium does not explain the decline in real interest rates, though the existence of a risk premium is one reason real rates are always low compared with the return on capital. In addition to risk, another reason the interest rate on government debt can fall below the net marginal product of capital is market power. If firms charge prices above marginal cost, there is a wedge between the cost of capital (as reflected by market interest rates) and the marginal product of capital An increase in the markup of 1 percentage point reduces the real interest rate by 8 basis points. Some of the literature suggests that markups have increased by 20 percentage points or more. This change could explain a decline in real interest rates of about 160 basis points. So where does that leave us? Let me suggest four tentative conclusions. The decline in real interest rates around the world over the past several decades is not a mystery. It appears to be the result of an increase in world saving, a decline in world growth, and possibly an increase in market power. Because interest rates are so low, greater government debt is most likely not problematic from a budgetary standpoint. The government can probably roll over the debt and the accumulating interest forever, in essence letting growth take care of the debt. There is an outside chance that this Ponzi scheme of perpetual debt rollover will fail. That possible outcome is especially dire because the failure makes an already-bad state of the world even worse Even if the perpetual debt rollover succeeds, the increased debt could still crowd out capital. If the economy’s capital stock is less than the Golden Rule level, as appears to be the case, this reduction in capital accumulation will, in the long run, depress not only labor productivity and real wages but also the resources available for consumption

We have also seen an acceleration in venture capital investment and the creation of billion-dollar unicorns. At the same time, capital intensive industries, like manufacturing, have also gradually decline as a share of GDP. (Risk-averse) savings have flowed into real estate at the margin, never more than prior to the financial crisis. In sectors where we have seen consolidation, we have seen market leaders invest more, grow productivity faster, and subsequently gain share relative to competitors—the opposite of oligopolistic behavior. Perhaps information technology and globalization are increasing economies of scale. Much of the consolidation occurred in sectors, like retail and wholesale distribution, where an influx of national chains into local markets increased competition despite a consolidation of national share. Much of the rest occurred in industries that remain below concentration levels antitrust experts view as anticompetitive. Excess profits seem to be concentrated in a small number of companies, many with low marginal costs and valuable networking effects who have benefited from one-in-a-million innovations. It’s hardly obvious that the expected values of those bets were positive before-the-fact. Venture capital returns, for example, have been mediocre on average. Rognlie and Karabarbounis have shown that excess profits were high relative to GDP in the ‘50s and ‘60s when industry concentration was lower, fell as interest rates rose through the early ‘80s, have risen as interest rates have fallen since, and that returns on real estate have followed a similar pattern. Those patterns cast doubts on whether the recent rise in profitability relative to GDP is a function of concentration, and not interest rates. Surely, after-tax profits are a better measure of changing profitability than theoretical markups over variable cost. Theory aside, surviving companies must cover their fixed costs. Despite increased concentration, we have also seen increased turnover in the Fortune 500, the Forbes 400, and CEO tenures—the opposite of oligopolistic behavior. Lastly, since the commercialization of the internet in the early 1990s, America, which Philippon and Eeckhout hold out as indicative of growing market concentration, has grown GDP per hour worked relative to Western Europe. …and that’s with a substantially higher share of low academic test-scores than Northwest Europe, during a time when the productivity growth of low-scorers seems to have slowed disproportionately in the face of an enormous (largely low-skilled) labor supply shock from baby boomers, women entering the workforce, immigration, offshoring, and automation. At the same time, America’s outsized contribution of innovation, defense spending, and healthcare profits have made Europe and the rest of the world more prosperous than they otherwise would be, suggesting relative US productivity growth is faster than it appears to be. Nothing is dispositive of course. But, with that many anomalies, a more explanatory hypothesis seems warranted. No?”

Might firms' use of data create market power? To explore this hypothesis, we craft a model in which economies of scale in data induce a data-rich firm to invest in producing at a lower marginal cost and larger scale. Just like managers are taught to do in MBA programs, the firm decision makers in our model make investment decisions, taking risk into account. It is this effective risk aversion that causes firms to invest more when they have more data. Data is a tool to reduce risk. With less risk from random demand, a larger investment becomes optimal. Thus high-data firms do invest more, grow larger and exert more impact on prices But this simple story delivered some unexpected additional effects. We found that when managers price risk, markups reflect both market power and a compensation for risk. If data reduces risk by making uncertain outcomes more predictable, then is also reduces the risk premium and the markup. At the same time, firms react to data about demand by shifting their production to high-demand goods. These are high-markup goods. So data changes the composition of production. This composition effect leads firms to shift production toward high markup goods, which raises markups. The tug-of-war between risk reduction and the composition effects induced by data plays out different for product, firm and industry markups. A model designed to explore the logic of data and large firms turned out to explain why econometricians got different answers about what was happening to markups over time when they measured at different levels of aggregation. Out model suggests an new interpretation of existing facts. Constant product markups and rising firm and industry markups are not competing facts. They are consistent with an economy where firms are getting better and better at forecasting future demand.

Jan Eeckhout and Laura Veldkamp, "Data and Market Power," National Bureau Of Economic Research, May 2022, https://www.nber.org/papers/w30022

Primary Results: How Data Affects Markups

“…Figures 1 and 2 illustrate how the risk reduction and investment forces compete. When firminvestments greatly decrease marginal cost (low cc), then the cost channel is dominant and more data primarily increases investment, lowers costs and raises markups (Figure 1). When the cost reduction investment is inefficient (high cc), then data still prompts more investment, but this has little effect on marginal cost. Instead, the dominant force is risk reduction. Similarly, if the price of risk is high, risk reduction is also the dominant force. A data-rich firm faces less cost from taking on more risk with a large production plan. By producing more, data-rich firms drive prices down and lower markups (Figure 2)…”