Measuring Productivity

I'm still discussing Erik Brynjolfsson and Andrew McAfee's book Race Against The Machine: How the Digital Revolution is Accelerating Innovation, Driving Productivity, and Irreversibly Transforming Employment and the Economy.

They make some very good points about measuring productivity. We don't account very well for improvements in quality as well as quantity, such as ease of use, say, or the availability of ATMs 24 hours a day.

Free digital goods like Facebook or Wikipedia are "invisible to productivity statistics". And we don't measure productivity adequately at all in two sectors which together make up the majority of the economy:

Furthermore, most government services are simply valued at cost, which implicitly assumes zero productivity growth for this entire sector, regardless of whether true productivity is rising at levels comparable to the rest of the economy. ..

Health care productivity is poorly measured and often assumed to be stagnant, yet Americans live on average about 10 years longer today than they did in 1960. This is enormously valuable, but it is not counted in our productivity data. According to economist William Nordhaus, “to a first approximation, the economic value of increases in longevity over the twentieth century is about as large as the value of measured growth in non-health goods and services.”

The point about healthcare is more optimistic than most views of healthcare spending. It is not all simply just cost inflation.

There are other negatives which may offset some of this - such as rising pollution, say. But over the long run productivity is THE main factor affecting growth and incomes. And we do not measure or understand it very well.

General Purpose Technologies

I'm discussing Erik Brynjolfsson and Andrew McAfee's book Race Against The Machine: How the Digital Revolution is Accelerating Innovation, Driving Productivity, and Irreversibly Transforming Employment and the Economy, a riveting, fascinating little distillation of many of the dilemmas of the modern economy.

We discussed their review of the different explanations of the problems in the labor market at present. They argue in some ways the predicament is worse than we realize. Researchers had thought that jobs like truck driver were almost impossible for machines to replicate. Then Google announced in late 2010 they had already been driving automated cars (accompanied by human drivers in the back seat) over thousands of miles of American roads.

Information technology is becoming a general purpose technology, much as steam power or electricity, they argue. It is something which spreads throughout an economy setting off "innovative complementarities" which feed on each other and trigger further rounds of change. It is causing a third industrial revolution.

In fact, the impact is potentially more profound than previous general purpose technologies because the advances in IT are so much larger. Computers are many thousands of times faster than they were thirty years ago. Steam power never advanced so much or so fast.

And it is not just a matter of computer hardware following Moore's Law and getting faster, either. The advances in software, such as better algorithms, is also accelerating. They cite a study which examined improvements in solving a standard optimization problem between 1989 and 2003. The solution routine improved 43 million-fold. The processor got 1000 times faster. The algorithm got 43,000 times better.

Gradual progress builds on itself and becomes exponential, especially as better tools help with the discovery and design of even better tools.

Large chunks of middle America may now be vulnerable to seeing their jobs automated.

These changes alter the distribution of rewards, too. "Winner-take-all" competition can increase the earnings of a few superstars at the expense of a wider range of people, for example. It used to be that if you were the best at an activity in your town, you had a living. Digital technology collapses distance. Now you may face competition from the person who is the best in the world.

This helps explain why incomes are increasingly skewed towards the top. It is not just exploitation by "the 1%" or "bankers". There are problematic structural changes in the underlying economy.

The companies who adapt best to this have changed their organizational structure and culture.

The most productive firms reinvented and reorganized decision rights, incentives systems, information flows, hiring systems, and other aspects of organizational capital to get the most from the technology.

Incidentally, this may be the main reason American firms have been more productive in recent years than similar British or Canadian firms within their own industries. American firms in their vast flexible internal market are often forced to make organizational innovations faster.

But even if we do our best to adapt, the pace of change may be very disruptive.

However, when the changes happen faster than expectations and/or institutions can adjust, the transition can be cataclysmic. Accelerating technology in the past decade has disrupted not just one sector but virtually all of them. A common way to maintain consumption temporarily in the face of an adverse shock is to borrow more. While this is feasible in the short run, and is even rational if the shock is expected to be temporary, it is unsustainable if the trend continues or, worse, grows in magnitude.

The problem is our skills and institutions can't keep up with the pace of change, they say.

What can we do about this?

Race against the machine

I mentioned Erik Brynjolfson and Andrew McAfee's book Race Against The Machine: How the Digital Revolution is Accelerating Innovation, Driving Productivity, and Irreversibly Transforming Employment and the Economy here, in the context of an NYT article.

I ordered and read the e-book, and it is a brilliant little gem which more than repays the few dollars it costs on Kindle. I thoroughly recommend that everyone who reads this should shell out the $2.99 it costs to read their intelligent, well-cratfed and insightful little e-book.

I want to take some of its ideas sequentially. The first is a review of the literature (more or less) on what is going wrong with the labor market. They identify three main explanations:

1. the cyclical explanation typfied by Paul Krugman. The main problem we have is an absence of demand.
2. the stagnation explanation, typfied by Tyler Cowen. We've picked all the "low-hanging fruit" and technological innovation has slowed down.
3. the "end of work" explanation , typified by Jeremy Rifkin's book of the same name The End of Work (which I have not covered or read, but will get to soon) which argues there is a much more deep-seated problem.

The authors come down on the side of the third explanation.

The root of our problems is not that we’re in a Great Recession, or a Great Stagnation, but rather that we are in the early throes of a Great Restructuring.

Technology may have outrun the ability of the economy and society to adjust. This is not a new observation.

The end-of-work argument has been made by, among many others, economist John Maynard Keynes, management theorist Peter Drucker, and Nobel Prize winner Wassily Leontief, who stated in 1983 that “the role of humans as the most important factor of production is bound to diminish in the same way that the role of horses in agricultural production was first diminished and then eliminated by the introduction of tractors.” In his 2009 book The Lights in the Tunnel, software executive Martin Ford agreed, stating that “at some point in the future—it might be many years or decades from now—machines will be able to do the jobs of a large percentage of the ‘average’ people in our population, and these people will not be able to find new jobs.” Brian Arthur argues that a vast, but largely invisible “second economy” already exists in the form of digital automation. The end-of-work argument is an intuitively appealing one; every time we get cash from an ATM instead of a teller or use an automated kiosk to check in at an airport for a flight, we see evidence that technology displaces human labor. ....

But low unemployment levels in the United States throughout the 1980s, ’90s, and first seven years of the new millennium did much to discredit fears of displacement, and it has not been featured in the mainstream discussion of today’s jobless recovery.

(I mentioned Brian Arthur's explanation here, and will cover Martin Ford soon.)

The economics profession pays little attention to third explanation - and in the past, they have been abundantly justified in doing so.

For over 200 years, the economists were right. ....However, this empirical fact conceals a dirty secret. There is no economic law that says that everyone, or even most people, automatically benefit from technological progress.

And that is the predicament in which we find ourselves today. It is not that all human workers are obsolete - as the drayhorses of the nineteenth century became - but may skills are becoming less valuable.

So we agree with the end-of-work crowd that computerization is bringing deep changes, but we’re not as pessimistic as they are. We don’t believe in the coming obsolescence of all human workers. In fact, some human skills are more valuable than ever, even in an age of incredibly powerful and capable digital technologies. But other skills have become worthless, and people who hold the wrong ones now find that they have little to offer employers. They’re losing the race against the machine, a fact reflected in today’s employment statistics.

I'll discuss these issues morei in the next post.

Protests erupt

Protesters in Zucotti Park last week. Things now feel much as they did in 2008-2009, with nasty surprises hitting the markets and politics and a sense that events are running out of control.

I've walked around the park a few times. I'm struck by how it has been taken over by any number of causes, from anti-fracking to student debt.

Greece looks worse and worse

There is increasing turmoil today over the on-again, off-again Greek referendum, a pulled EFSF bond auction, widening Italian spreads and, far in the background , France's AAA rating.

What a mess.

Europe is going to have to go through a wrenching adjustment of all its certainties, including the modern welfare state. The latest great European summit solution last Wednesday night lasted less than three business days.

Creativity in the Parade

We didn't go down to Greenwich Village last night for the Halloween Parade, but we caught some of it on NY1. The creativity of some of the costumes is remarkable. People must spend weeks getting ready. One that struck me in particular - and unfortunately I haven't found an image yet - is two women who went as the Brooklyn Bridge. Each was one of the towers, with the deck of the bridge between them.

There is a lot of latent creativity out there, which presumably people do not have a full outlet for in their day jobs. The vaguely countercultural and clothes-conscious parade lets it flow.

Enlightenment rationality means declining violence?

I'll have to put Steven Pinker's new book, The Better Angels of Our Nature: Why Violence Has Declined , as it seems to be one of the major talking points of the year (especially in the UK, for some reason). Here is a review by John Gray in Prospect Magazine disagreeing with Pinker's argument that we have made progress in containing violence.

Science and humanism are at odds more often than they are at one. For a devoted Darwinist like Pinker to maintain that the world is being pacified by the spread of a particular world view is deeply ironic. There is nothing in Darwinism to suggest that ideas and beliefs can transform human life. To be sure, there have been attempts to formulate an idea of progress in terms of competing memes—vaguely defined concepts or units of meaning that are held to be in some ways akin to genes—although nothing like a scientific theory has been developed. Even if there were such things as memes and they did somehow compete with one another, there is nothing to say that benign memes would be the winners. Quite to the contrary, if history is any guide.

We have hit a wall on responsibility and reward

This is a very stimulating article in New York's City Journal, by a University of Chicago professor, Luigi Zingales, who argues that you cannot look at an economic system in isolation from "who gets what".

The fundamental role of an economic system, even an extremely primitive one, is to assign responsibility and reward. In animal packs, the responsibility of leadership and the reward of mating opportunities are generally assigned to the strongest. In human societies, responsibility tends to take the form of employment, and the rewards are money and prestige. Because physical strength has long since lost its importance, economic systems determine in various ways who receives the responsibilities and the rewards. The dominant criterion in traditional society was birth: the king’s firstborn son was the next king; the landowner’s firstborn son, the new landowner; and the son of the company’s owner, the next chief executive. Most modern societies, by contrast, try to select and reward according to merit. Indeed, surveys show that in the abstract, most people in developed countries agree with the idea that merit should be rewarded.

It isn’t easy to decide what constitutes merit, of course.

On one level, this is obvious. We argue all the time about redistribution and whether the rich should pay more taxes, or the size of the welfare state.

But in another way, it explains why our politics has got so stuck. Just as birth is no longer an acceptable justification for distributing rewards, we have more and more problems over what happens when a market system starts evolving beyond the original set of circumstances which made it work. We have an outworn system of deciding responsibilities and rewards, a constant rerun of the 20th century argument about the role and size of the state.

We are going through another enormous shift in the underlying legitimacy and nature of "who gets what". The answers for an industrial economy are no longer good enough. What if many of the things we value can be produced for a marginal cost of close to zero - and priced more like fresh air or water, rather than automobiles or bushels of wheat?

How do we reward people through employment institutions if employment itself is changing rapidly in many ways - if automation threatens to make any job which can be routinzed as much a matter of history as Summerian fertility gods?

How do we decide merit or productivity if those are intrinsically hard to observe in many knowledge worker occupations, or only one winner of a race of many thousands - such as to develop alternative energy- makes any money?

And to add to the difficulties, merit itself may be increasingly less accepted as a suitable criterion.

Zingales notes that it is often hard to sustain a meritocratic system. Majorities become envious of greater rewards going to a "meritocratic" minority. Moreover, in monopolies and governments, it almost always pays to put loyal supporters into prime positions, not the most creative or productive.

In politics, for example—a field in which value is mostly redistributed rather than created—the benefits conferred by meritocracy are relatively small compared with the benefits conferred by cronyism. If I appoint my friends to office, even when they aren’t terribly competent, I lose relatively little efficiency and gain quite a lot of power. Hence meritocracy is difficult to sustain in government.

The same is true when a firm enjoys a monopoly. Since the firm’s market position isn’t at risk, it doesn’t benefit much from hiring the best people. Instead, its executives focus on bureaucratic infighting, trying to grab an ever-larger share of the profits from one another, and once again, hiring loyal workers pays more than hiring competent ones.

In firms facing stiff competition, though, it pays to recognize merit because survival is at stake. Better a smaller slice of a growing pie than a huge share of no pie at all.

The market system works because it incentivizes efficiency rather than cronyism. and because most people believe the outcome is broadly fair.

If too many people believe that the rewards of meritocracy are not fair, the system can be undermined.

So here's the thing. We have reached an impasse about what constitutes "fairness". Many people do not believe higher levels of taxation for redistribution as entitlement spending is fair. Even if they did, the crisis of the welfare state in Europe and yawning fiscal deficits in state and local government in the US suggest it is not a sustainable idea anyway. One of the problems that Occupy Wall St protestors face is that as they sit shivering in their snow-covered tents in Zucotti Park, the federal government continues to spend vastly disproportionate resources on the elderly. The elderly have huge political power, 20-year olds with no health insurance and heavy student loans do not.

On the other side, many people do not believe that increasing inequality in society is fair. Somehow the world of work and employment and the economy in general is turning into a "winner-take-all" game.

But you still need to reward creativity and skill and merit (however defined) rather than cronyism and court politics. The great overwhelming virtue of a market system is it puts pressure on bureaucracy and status-laden hierarchy and cronyism, that kept the world mired in poverty for thousands of years.

We will never be able to change the current economic system for the better unless an alternative system of rewards is seen to be honest and reward the responsible and productive. The left cannot achieve the change it wants unless it deals with this problem. Income redistribution by the government simply does not meet that criterion. It is stale, It is done. It is over.

And as I keep arguing. you cannot get some consensus on a better alternative system of rewards unless you have a better sense of what the purpose of the economy and society and government is, what the nature of the good life may be. We have to drop the idea of the neutral state, which carries with it the idea of purely neutral allocation by the market mechanism, which liberals of both left and right (libertarians) believe in so strongly.

We cannot progress because our dominant underlying political ideology in the west, liberalism in the broad sense, cannot see there is a problem.