Productivity

admin — Fri, 26 Jun 2009 21:35:10 +0000

Last but not least, we look at how productivity growth can affect the equilibrium real exchange rate. What is productivity? We have a vague concept of this in our work place, but it has a precise deﬁnition — output per man hour. Rising productivity growth causes increased supply of a good. Supply/demand dynamics require that increased supply relative to demand leads to a fall in price. The principle of Purchasing Power Parity requires however that falling prices in one country relative to another lead to an offsetting exchange rate appreciation under the law of one price. Thus higher productivity growth in tradable goods should lead to exchange rate appreciation to restore equilibrium to the current account.
The issue of productivity growth was much in debate in 2001 as economists sought to explain the US dollar’s inexorable rise against the Euro. Indeed, both the Federal Reserve Bank of New York and the Bank of England produced reports on the issue of whether higher US productivity growth explained the US dollar’s strength and indeed whether or not the US did in fact produce higher productivity growth. Despite the presence of such eminent scholarship, the jury is still out. There does however seem to be greater clarity at least as regards the broader issue of whether or not productivity growth should produce exchange rate appreciation. Just as PPP is not a good short-term predictor of exchange rates, so productivity growth should not be used as a short-term trading model. However, both are profoundly useful in predicting medium- to long-term exchange rate trends. Here, the fact that the US has had consistently higher productivity growth in the wake of the “re-engineering” drive within the US economy in 1994–1995, and the fact that the US dollar has been on a long-term uptrend ever since, should not be seen as coincidence. Similarly, Japan during the 1970s and 1980s had consistently higher productivity levels than either the US or Europe, and this should be seen as at least one of the major reasons why we saw trend appreciation of the Japanese yen during that period.
Yet, at some point productivity growth becomes unsustainable. After all, it deals with the issue of increased supply, presuming that there is always demand for that increased supply. At some point, the levels of supply will exceed demand. When that happens a hitherto unforeseen “inventory overhang”, as per the economists’ jargon, appears. The natural dynamics of supply and demand suggest that the excess supply should instantly be eliminated to restore “equilibrium” supply levels relative to demand. Yet, we know from painful experience that this is not what happens. If we view productivity as supply and wages as demand, the standard economic model suggests that higher productivity growth automatically results in higher wages. Yet, during periods of major technological change, which tend to produce the strongest levels of productivity growth, the fact that competition is greatly increased produces such downward pressure to prices to the extent that the only way some can compete is to cut wage growth. At the very least, wage growth does not keep up with productivity growth. In other words, demand does not keep up with supply — which brings us back to the idea that this excess supply will rather quickly have to correct automatically to match the level of demand.

Financial issues » productivity

Productivity