Transcript: 500 Productivity,(updated with chart) Innovation, Flat Supply Curve

Today on the podcast – wait, wait, wait – this is the 500th podcast of Demand Side Economics. Number 500. We've been broadcasting since October 2007. You may remember the story. We rushed to air so as to not get left behind in calling the onset of the recession that began in December. More effort than necessary. Most economists hadn't called it by May 2008. In any event, we've learned a lot over the past nearly five years. We hope it stimulates a little in you.

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We should celebrate. Maybe issue a book. Yes. That's it, we'll do a book. Out May 15 the final first edition of Demand Side the Book, available now in rush version at Demand Side Books dot com. Pristine final version May 15. Our favorite response so far, "This is really clear. Are you sure it's economics?" Yes, it's economics absent neoclassical lighting and cobwebs. Oh, and thanks, Mom.

But on to economics. Last week we slipped into the muck of commodity market manipulation. That with the relay of a Congressional hearing on the casino featuring Michael Greenberger. Today we'll talk about innovation, productivity and take a look over the fiscal cliff if we have enough time.

I'm getting excited. Must be the champagne.

Anyone who's involved in economics, and my training is indeed in economics, knows that the long-term growth and success of any economy is really related to the innovation that we see, related to not just those people who study the so-called STEM subjects, science, technology, engineering and math, but all the rest of us who benefit from what they have developed, number one. Number two -- we also track what corporations are doing. Are they investing in capital? Are they investing in their people?

Abbey Joseph Cohen, Idiot of the Week

Innovation will lead us out, neoclassical growth theory, not going to happen. The US leads in innovation, lags in employment, as manufacturing is shipped overseas in spite of our yawning trade deficit. I wonder what the world would look like if goods were traded for goods.

Innovation, we've argued arises from the soil of good basic education and subsidized R&D, through research universities and the public sector – often the Defense Department, most often with strong demand from the public sector, often the Defense Department.

In reading Steve Keen's indispensible Debunking Economics – maybe not as clear as our Demand Side Economics, but likely more satisfying to the serious student – we find from page 114,

the Hungarian economist Janos Kornai.

Kornai's analysis was developed to try to explain why the socialist economies of eastern Europe pre-1990 had tended to stagnate (though with superficially full employment), while those of the capitalist West had generally been vibrant (though they were subject to periodic recessions). he noted that the defining feature of socialist economies was shortage:

In understanding the problems of a socialist economy, the problem of shortage plays a role similar to the problem of unemployment in the description of capitalism." (Kornai 1979: 801).

Seeing this as an inherent problem of socialism—and one that did not appear to afflict capitalism—Kornai built an analysis of both social systems, starting from the perspective of the constraints that affect the operations of firms:

The question is the following: what are the constraints limiting efforts at increasing production? [...] Constraints are divided into three large groups:

1. Resource constraints: The use of real inputs by production activities cannot exceed the volume of available resources. These are constraints of a physical or technical nature [...]
2. Demand constraints: Sale of the product cannot exceed the buyers' demand at given prices.
3. Budget constraints: Financial expenses of the firm cannot exceed the amount of its initial money stock and of its proceeds from sales. ...

Which of the three constraints is effective is a defining characteristic of the social system [...]

Kornai concluded that

With the classical capitalist firm it is usually the demand constraint that is binding, while with the traditional socialist firm it is the resource constraint."

That meant there were unemployed resources in a capitalist economy—of both capital and labor—but this also was a major reason for the relative dynamism of capitalist economies compared to socialist ones. Facing competition from rivals, insufficient demand to absorb the industry's potential output, and an uncertain future, the capitalist firm was under pressure to innovate to secure as much as possible of the industry's demand for itself. This innovation drove growth, and growth added yet another reason for excess capacity: a new factory had to be built with more capacity than needed for existing demand, otherwise it would already be obsolete.

Therefore most factories have plenty of 'fixed resources' lying idle—for very good reasons—and output can easily be expanded by hiring more workers and putting them to work with these idle 'fixed resources.' An increase in demand is thus met by an expansion of both employment of labor and the level of capital utilization—and this phenomenon is also clearly evident in the data.

Kornai's empirically grounded analysis thus supports Sraffa's reasoning: diminishing marginal productivity is, in general, a figment of the imaginations of neoclassical economists. For most firms, an increase in production simply means an increased use of both labor and currently available machinery: productivity remains much the same, and may even increase as full capacity is approached—and surveys of industrialists ... confirm this.

So the capitalist is under pressure to innovate to secure as much of the available demand as possible.

We would add the capitalist seeks to control demand with advertising and promotion, as well, scientific mind manipulation.

But Keen leads us into the next issue of today. Productivity.


He does it by noting that the supply curve taught to you and me in 101 is not visible in the real world. The upward sloping supply curve is a vestige of the 19th Century, when agriculture under heavy demand would move to less hospitable acreage and yields would go down. Less productive soil mean higher costs per bushel.

Hasn't happened that way in the real world for a century. As Keen points out, capitalists plan their facilities so it doesn't. High fixed costs are averaged down the more units that are produced. Plus the marginal cost of a new worker actually results in just as much product as the last worker, right up to capacity. In fact, the average cost per unit is going down. Right up to the last station on the third shift. Not to mention we haven't gotten close to capacity in decades, and are trending down.

Not new to listeners of the podcast – about capacity anyway—though to read Keen and recognize the supply curve is not rising, but is flat or downward sloping until near the end makes me want to paint the iconic X supply-demand curve on the office door of Professor Brown. You'd think he'd check with the capitalists before he taught that to the hundreds of naive young business students.

One academic did ask the capitalists and found less than 10 percent reported the classic rising supply curve. Those ten percent were concentrated in industries with key supply constraints. More than 90 percent reported downward sloping, then nearly flat or slightly rising supply curves. Oops. Not 90 percent. Well, zero reported rising supply curves from the get-go. But 17 reported that at least near capacity there was a sharp rise. Fully 316 firms, that's 316 versus 17, more like 95 percent reported downward sloping then nearly flat or slightly rising supply curves.

That's disgusting. But what it means is output is determined by demand, where demand crosses this downward sloping then flat supply curve.

Now Productivity leads us back to the Rule of Eight, a Demand Side invention that—or observation—that describes the relationship between unemployment and productivity. Eight minus the rate of unemployment in the medium and long term determines the rate of productivity—output per hour nonfarm businesses. The higher the unemployment rate, the lower productivity. The lower the unemployment rate, the more managers manage for efficiency and the more productive workers are.

You may remember our sinuous chart, which we've updated through the end of 2011 on the transcript.

Wait! Wait! Wait! Didn't we hear unending bleats that people were working harder to keep their jobs and managers were speeding up the line with the Great Recession's job losses?

Ah. The short term. The short term is often in the opposite direction. We would describe it as the systems developed by workers whose desks are now empty are being used by the remaining workforce. But whatever its cause, the general conventional wisdom was so insistent we lay low for awhile. Now we see productivity collapsed in 2011. The rule of 8 would say it should be around zero or even below, since unemployment is above eight. But these are unusual times. 2011 did have some negative numbers in it, including minus 1 percent annualized in the first quarter, but it eventually came in above the zero line at 0.4 percent. A far cry from the 4 percent of the year before or the 2.3 percent from 2009 or the three and a half of earlier in the decade or the 1990s.

So, productivity having collapsed, we can peek out again, and put up our chart, and even point to a new source, the survey by Eiteman and Guthrie. When was that? Ah, new information. 1952. This empirical data contradicting the upward sloping supply curve has been on the books for sixty years of X marks the spot in the supply-demand pages of price theory instruction.

Where's my spray can?