Labor markets and the great stagnation
I avoided commenting on the Great Stagnation back when I first read it however long ago, mostly because everyone in the world was commenting on it and I wasn’t sure whether I could really add anything new. Here, much delayed, is my two cents, reflecting some thinking I’ve been doing about labor markets recently.
As my entire working life has been primarily focused on fast growing emerging markets, the concept that “we” are in an extended period of stagnation struck me at first as being somewhat overly limited in scope. The way I largely understand the economy of the past two decades (not an economist), is high levels of emerging markets growth linked to disinflation in developed markets, providing a form of global growth all around. The fact that the consequences of long-term disinflation and low-interest rates ended up being a speculative bubble that more or less destroyed 10 years of growth, indicates though that there was something wrong with the global growth pattern. At least in the developed world.
On second thought though this plays fairly well into Cowen’s argument. It strikes me that the major difference between developed world growth and developing world growth during this period is that while globalization led to an unprecedented growth in the supply of labor for the developed world, it also led to an unprecedented growth in the demand for labor in the developing world. And historically undersupply of labor has been linked to productivity enhancing investment and innovation.
Since the late Medieval Period (in fact, since the Black Death of 1348), the North Sea area was a region with high real wages and low interest rates, and producers had developed and selected production technologies which are consistent with these relative prices. Meanwhile, in China – in the Yangzi delta and elsewhere – wages were much lower, and capital markets probably not that well developed as in Western Europe. A comparison of production techniques used in different industries is illuminating.
In China, water management was carried out largely by hand using sophisticated machines (see Figure 1 below). In the Netherlands the windmill had been adapted to service water management, resulting in the huge mills that dominated the rural landscape (Figure 2 is a design of one of the first 17th century mills). The same difference applies to oil pressing, a large industry in both regions. The Dutch developed a highly capital-intensive windmill technology to press their oilseeds, the Chinese version of this was driven, again, by humans or oxen. Inland transport along canals and rivers was pulled by horses in the Netherlands, by humans in China.
Most famous is perhaps the different choice of technique in printing. Although the Chinese had invented the printing press, commercial printers preferred to use a more labour-intensive technology, woodblock printing. Since the middle of the 15th century, Western Europe concentrated on moveable type printing as the most important technology, which was a very capital-intensive process, with high levels of labour productivity. Figures 3 and 4 illustrate the difference in capital-labour ratio between the two technologies; typically, the pressing in China is done by humans, in Europe by a machine.
Or in other words, while we are benefitting from rapid productivity advances in the developing world, we have less incentives to invest in productivity enhancement in the US.
If this analysis is correct than targeting emerging market demand would be the best way to enhance the United States’ innovation capacity. You can see this fairly clearly in the industrial equipment sector where companies like Caterpillar are making money hand over fist selling to emerging markets. And on the slightly more innovative side, Greentech companies are now almost specifically tasked with dealing with the problems that have arisen from the various resource shortages associated with China’s growth.
While trade often gets blamed for causing the labor surplus that we are now dealing with, I don’t think it’s properly appreciated how the rise of the emerging world is a once in a life-time opportunity for labor market upgrading. Productivity enhancements that we create elsewhere will all eventually comeback to us in the form of cash to spend on those goods that we no longer have to make ourselves. If, of course, we can just stand to look beyond our borders.