"Kee" Points with Jim Kee, PhD.

Thoughts on growth: With all of the talk about how to generate economic growth lately, I thought I would share some thoughts on the subject from economists who aren’t exactly household names, but should be. Norman B. Ture, a Reagan and Kennedy administration economist, always started discussions on economic growth by pointing out that increases in economic output can only occur if there is an increase in the number of productive inputs (labor and capital) or in the efficiency of their use.

A limitation of current commentary and analysis on the subject, including organizations like the International Monetary Fund (IMF) and the Organization for Economic Co-operation and Development (OECD), is that they treat the number of production inputs (labor and capital) as a passive function of time or of the age composition of the labor force. But the amount of productive inputs supplied also depends upon the rates of return to their employers. The number of workers and the number of hours worked, as well as the amount of capital supplied to risky ventures, depends in part upon the potential rewards or returns that can be expected. Those returns and rewards are affected in no small part by tax and regulatory policies. To ignore the fact that the supply of labor and capital depends in part on the prices they receive, is to engage in what economist Lord P.T. Bauer used to call “priceless economics” and it is something that I increasingly see in writings on the topic of economic growth.

On the efficiency of the use of productive inputs or productivity (output per unit of input) there are some interesting albeit lesser-known insights on this subject as well. Nobel Laureate Edward Prescott recently discussed the topic in a paper published in Business Economics, the journal of the National Association of Business Economists (NABE). Prescott argued that productivity is best thought of as a measure of the efficiency (clarity and permanence) of a country’s legal and regulatory system, in the same way that profit is a measure of the efficiency of a business. That’s an interesting way to look at it, and here’s why:

UCLA economist Arnold Harberger argued (in his Presidential Address to the American Economic Association in 1998) that gains in productivity, which are really innovations, occur at the level of the individual business enterprise. They occur in “1001 ways,” said Harberger, from playing music in a factory to adjusting compensation schemes. They tend to pop up sporadically, like mushrooms, rather than evenly throughout the economy, like yeast. The title of the speech was “A Vision of the Growth Process” and the mushrooms versus yeast analogy is a fascinating descriptive of that vision. Technology writer George Gilder, writing on the same topic but borrowing from information theory, argued that the more stable and changeless the policy environment (i.e. monetary and fiscal policy), the more dynamic, changing, and innovative the economic environment. Likewise, if the policy environment is always in a state of flux, you get less productivity and innovation. So you can apparently increase the frequency of “mushrooms” popping up (i.e. innovations and productivity gains) with a stable and predictable policy environment, and that’s what Edward Prescott meant when he said that productivity is a measure of the efficacy of a country’s legal and regulatory institutions.

Finally, one criticism of the behavior of firms, where productivity is asserted to take place, is that they are focused too much on short-term profits; “quarterly capitalism” as the politicians have called it. This means that you don’t get as many productivity gains as you could if firms managed with a longer-term vision. This is a decades-old critique of business and it seems intuitive to anyone who has ever worked for a business firm. But it doesn’t exactly hold up to scrutiny. For example, the charge that firms sacrifice long-term wealth creation for short-term gains implies that an investor could invest in firms that take actions which lower short-term quarterly earnings, but ultimately increase long-term firm value. You could test this by buying the stock of firms that spend more on research and development, or capital spending in general, which lowers quarterly earnings, but increases firm values in the long-run if the firms are profitable to begin with. And yet, academics who have conducted this very test, have found that it would not be a profitable strategy. A report on this subject (of short-termism) by the University of Chicago recently asked, “How can US companies excel at generating increasing profits over a 30-year period and, at the same time, be mortgaging the future for the short run?” It’s a good question, and one that has seldom been asked by a press uncritical of the short-termism charge. In my opinion, a good part of the answer lies in the assertions of the management literature that a big part of managing successfully is “instilling a sense of urgency.” That is hard for any firm to do day-in-day-out and year-in-year-out, but managing with an eye to quarterly profits probably helps in no small way to achieve it.