So, I am strongly inclined to believe that I must be missing something here, because this post by Mike Mandel – hat tip Tyler Cowen – seems wrong in almost every single respect. Like Mandel’s original this post also got out of hand. I tried to cut a bit, but this is still what I got.

Let me hit on some highlights.

Mandel says

Based on my analysis, I estimate that the actual productivity gains in 2007-2009 may have been very close to zero.  In addition, the drop in real GDP in this period was probably significantly larger than the numbers showed.  I then explore some implications for economic policy.

Its my understanding the BEA backs out productivity gains from GDP gains. So, it doesn’t make sense to say that industry level productivity is inaccurately measured and therefore GDP is wrong. It can makes sense that productivity is inaccurately attributed to the wrong industry – a conclusion we will explore more below.

The only way to get GDP wrong is either to miscount the number of goods and services sold in the US or to misestimate the price index of final goods – not intermediate goods.

Mandel goes on

If productivity was rising, then the job loss was due to a demand shortfall and could be dealt with by stimulating aggregate demand. That, in turn, helps explain why the “job problem”  didn’t seem so urgent to the Obama administration, and why they spent more time on other policy issues such as healthcare and regulation.

This is backwards. The Obama administration focused on aggregate demand despite the surge in productivity. Imagine that productivity GDP actually grew during 2007 – 2009 despite a sharp rise in unemployment. That would indicate that productivity was growing like gang-busters. However, economists would be stumped. A pure NGDP guys like Summers would be forced to say “what recession”

Someone who leans heavily on industrial production numbers like myself would likewise be scrambling for an explanation. In the end we would have to say that this represents a “deep structural shift within the US economy.”

The productivity surge in other words helps the structural case because it is saying that we can in fact do more with less, not just that we are buying less.

Mandel again

With a little bit of figuring, I can calculate the performance of the top 10 industries versus the rest of the economy.  So the top 10 industries had a productivity growth rate of more than 6% per year during the financial crisis, while the rest of the economy had negative productivity  growth. So clearly if we want to understand the mystery of the productivity boom, we need to understand how these industries apparently did so well while the economy was tanking.

I like this approach, I do. I think deconstruction is key to unmasking what productivity means. However, I think Mandel is pushing it too far. Especially, in light of what he writes later.

Let’s start with primary metals, which includes steel, aluminum, and other metals. According to the BEA’s official statistics, real value-added in the primary metals industry–steel, aluminum and the like–rose by a total of 5.3% from 2007 to 2009 (this is a cumulative figure, rather than an annual rate).   If this statistic is correct, this is a truly amazing performance by an industry which went through tough times over the past twenty years. The performance is especially inspiring given that the auto industry–one of the biggest customers for steel–was completely flattened by the crisis.

But a look at physical output–steel and aluminum production, measured in tons–tells a much different story. In fact, over this two year period, steel production cratered by more than 40%. Aluminum production wasn’t hit as badly, but it too fell. And the Federal Reserve’s industrial production index for primary metals fell sharply as well.

Unless I am missing something what is going on is pretty clear. As the price of raw materials rose in the lead up to the recession measured productivity stalled. As prices collapsed measured productivity soared.

FRED Graph

On one level this is completely real because it measures the extent to which we are getting more out of labor. If suddenly someone discovered a new deposit of virtually unlimited raw materials that would be a wonderful improvement for most workers. It wouldn’t be an innovative increase in productivity but it would represent more low-hanging fruit in Tyler’s words.

On another a deeper level is represents the resilience of American production. Essentially, it saying when  raw materials became more scarce we found a way to make do make the same amount with less, then when bounty returned we produced more.

Mandel goes on to make more or less the same point about computers

First, real gross output fell by about 6%.  If you think of that as sales of domestically produced electronics equipment, adjusted for inflation, that sounds about right. Second–and this is the weird one–the official data apparently shows that intermediate inputs fell by 27%.  In other words, to produce 6% less gross output over the course of two years,  manufacturers managed to figure out a way to use 27% less inputs, both imported and domestic, in only two years.

This apparent fall in intermediate inputs is what drives the entire stellar productivity performance of the industry.  So now we must ask ourselves the question: Is it reasonable that domestic electronics manufacturers could achieve such efficiencies in only two years that they could produce almost as much output with so much less input?  In theory, I guess it can’t be ruled out.

We would expect that as U.S. IT hardware companies outsourced more and more of their manufacturing and services to Asia,  the ratio of intermediate inputs to output would have gone up.  After all, the IT industry is the world champion in outsourcing. But when we look at the data, we see something weird.

Again here cost is a potential driver though the gains are even more firm here than in materials. In materials we might argue that as China begins to rebuild those productivity gains will actually reverse. In computers not so much.

More Mandel

The official data are even harder to believe when it comes to imports. We all know that anything electronic that you buy is packed full of imported components. But according to the official numbers, imported intermediate inputs have been falling as a share of gross output, to well under 10%. Odd.

Is this really odd? I don’t know the real number but certainly the tech guys make it sound as if the actual cost of the “stuff” that goes in your phone is like $10, which is why the price of all phones eventually tends towards zero.

The cost of phones they say is the cost of engineering, design and programming. They use early adopters to make back those costs and then once they are done they sell the last few units at production costs which are barely distinguishable from zero.

To the extent Apple can squeeze it suppliers while producing really high valued products  this seems like the essence of productivity growth. We have both lower input costs and higher value for the consumer.

Mandel even has a graph that shows this

He says

This makes no sense at all. It simply doesn’t fit with the evidence of our eyes.

Really? It seem perfectly consistent.

I have been saying for a long time that we are reaching the end of “stuff.” Indeed, that is part of our structural problem. Bigger isn’t better anymore. So the people whose job it is to provide the actual parts are not only less essential but outright unwanted. There really are areas where we are reaching zero marginal product in the gross manipulation of materials. That is the bending of steel and shaping of plastic.

What is valued are those products in a smarter configuration. Better recipes, I think Arnold Kling says.

Mandel in his explanations says

Three, in product categories with declining prices and rapid model changes–such as cell phones, computers, consumer electronics–the official import price indices underestimate the size of the price decline for product categories with rapid model changes (I call this the ‘Nakamura-Steinsson effect,’ after the two economists who discovered it). The reason is simple–when a new model of an  imported good is introduced, the BLS typically treats it as a new good, and misses all the price decline from one model to its successor

Now you are speaking my language. If what are really saying is that the productivity gains are happening in foreign county then I can buy that.

However, this still shouldn’t affect final GDP or productivity per hour of US workers. An improvement in the terms of trade, which is what Mandel is identifying, is a productivity improvement for US workers. Its not based on US innovation, but it does lead to more output per US worker.

Mandel goes starts his conclusion

First, the measured rapid productivity growth allowed the Obama Administration to treat the jobs crisis as purely one of a demand shortfall rather than worrying about structural problems in the economy.  Moreover, the relatively small size of the reported real GDP drop probably convinced the Obama economists that their stimulus package had been effective, and that it was only a matter of time before the economy recovered.

A more accurate reading on the economy would have–perhaps–cause the Obama Administration to spend more time and political capital on the jobs crisis, rather than on health care. In some sense, the results of the election of 2010 may reflect this mismatch between the optimistic Obama rhetoric and the facts on the ground.

Again this seems confused. Measured productivity growth undercuts the demand story. The small size in the fall of real GDP, wasn’t mis-measured even if everything Mandel says is true.

Here I think we finally have a meeting of the minds

But there’s a broader issue as well.  As we saw above, the mismeasurement problem obscures the growing globalization of the  U.S. economy, which may in fact be the key trend over the past ten years. Policymakers look at strong productivity growth, and think they are seeing a positive indicator about the domestic economy.  In fact, the mismeasurement problem means that the reported strong productivity growth includes some combination of domestic productivity growth, productivity growth at foreign suppliers, and productivity growth ”in the supply chain’ . That is, if U.S. companies were able to intensify the efficiency of their offshoring during the crisis,  that would show up as a gain in domestic productivity. (The best case is probably Apple, which has done a great job in managing its supply chain for the iPod, iPhone and iPad and extracting rents).

From an economic and policy point of view, there’s a big difference between purely domestic productivity gains, productivity gains at foreign suppliers, and productivity gains ‘in the supply chain’.  The benefits of domestic productivity gains will like accrue  to the broad array of production and nonproduction workers in the U.S.  The benefits of productivity gains ‘in the supply chain’ will likely go to the executives and professionals, both in the U.S. and outside, who set up, maintain, improve, and control supply chains. That’s a much smaller, globally mobile group.  And the benefits of productivity gains at foreign suppliers? Well, that depends on how much power U.S. buyers have vis-a-vis their suppliers…that is, competitiveness.

Ok, yes and no.

Its definitely the case that intensifying the efficiency of your offshoring supply chain would show up as a productivity gain, and that is completely consistent with what the statistics are supposed to tell us.

On Mandel’s second point, that this means that gains are likely to accrue to supper stars – maybe. It depends on how rare supply chain thing management skills are. If everyone and his brother where Skypeing China to get the lowest input price then would expect broad gains in the US economy.

If it takes special skills and contacts to penetrate the offshoring market then rents will accrue.

Further, if only certain products are offshorable, then those who own the limiting factors of their production will benefit disproportionally.

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