Productivity: Do Low Real Wages Explain the Slowdown?

GDP per Worker, 1947Q1 to 2016Q2,rev

A.  Introduction, and the Record on Productivity Growth

There is nothing more important to long term economic growth than the growth in productivity.  And as shown in the chart above, productivity (measured here by real GDP in 2009 dollars per worker employed) is now over $115,000.  This is 2.6 times what it was in 1947 (when it was $44,400 per worker), and largely explains why living standards are higher now than then.  But productivity growth in recent decades has not matched what was achieved between 1947 and the mid-1960s, and there has been an especially sharp slowdown since late 2010.  The question is why?

Productivity is not the whole story; distribution also matters.  And as this blog has discussed before, while all income groups enjoyed similar improvements in their incomes between 1947 and 1980 (with those improvements also similar to the growth in productivity over that period), since then the fruits of economic growth have gone only to the higher income groups, while the real incomes of the bottom 90% have stagnated.  The importance of this will be discussed further below.  But for the moment, we will concentrate on overall productivity, and what has happened to it especially in recent years.

As noted, the overall growth in productivity since 1947 has been huge.  The chart above is calculated from data reported by the BEA (for GDP) and the BLS (for employment).  It is productivity at its most basic:  Output per person employed.  Note that there are other, more elaborate, measures of productivity one might often see, which seek to control, for example, for the level of capital or for the education structure of the labor force.  But for this post, we will focus simply on output per person employed.

(Technical Note on the Data: The most reliable data on employment comes from the CES survey of employers of the BLS, but this survey excludes farm employment.  However, this exclusion is small and will not have a significant impact on the growth rates.  Total employment in agriculture, forestry, fishing, and hunting, which is broader than farm employment only, accounts for only 1.4% of total employment, and this sector is 1.2% of GDP.)

While the overall rise in productivity since 1947 has been huge, the pace of productivity growth was not always the same.  There have been year-to-year fluctuations, not surprisingly, but these even out over time and are not significant. There are also somewhat longer term fluctuations tied to the business cycle, and these can be significant on time scales of a decade or so.  Productivity growth slows in the later phases of a business expansion, and may well fall as an economic downturn starts to develop.  But once well into a downturn, with businesses laying off workers rapidly (with the least productive workers the most likely to be laid off first), one will often see productivity (of those still employed) rise.  And it will then rise further in the early stages of an expansion as output grows while new hiring lags.

Setting aside these shorter-term patterns, one can break down productivity growth over the close to 70 year period here into three major sub-periods.  Between the first quarter of 1947 and the first quarter of 1966, productivity rose at a 2.2% annual pace.  There was then a slowdown, for reasons that are not fully clear and which economists still debate, to just a 0.4% pace between the first quarter of 1966 and the first quarter of 1982.  The pace of productivity growth then rose again, to 1.4% a year between the first quarter of 1982 and the second quarter of 2016.  But this was well less than the 2.2% pace the US enjoyed before.

An important question is why did productivity growth slow from a 2.2% pace between the late 1940s and mid-1960s, to a 1.4% pace since 1982.  Such a slowdown, if sustained, might not appear like much, but the impact would in fact be significant.  Over a 50 year period, for example, real output per worker would be 50% higher with growth at a 2.2% than it would be with growth at a 1.4% pace.

There is also an important question of whether productivity growth has slowed even further in recent years.  This might well still be a business cycle effect, as the economy has recovered from the 2008/09 downturn but only slowly (due to the fiscal drag from cuts in government spending).  The pace of productivity growth has been especially slow since late 2010, as is clear by blowing up the chart from above to focus on the period since 2000:

GDP per Worker, 2000Q1 to 2016Q2,rev

Productivity has increased at a rate of just 0.13% a year since late 2010.  This is slow, and a real problem if it continues.  I would hasten to add that the period here (5 1/2 years) is still too short to say with any certainty whether this will remain an issue.  There have been similar multi-year periods since 1947 when the pace of productivity growth appeared to slow, and then bounced back.  Indeed, as seen in the chart above, one would have found a similar pattern had one looked back in early 2009, with a slow pace of productivity growth observed from about 2005.

There has been a good deal of work done by excellent economists on why productivity growth has been what it was, and what it might be in the future.  But there is no consensus.  Robert J. Gordon of Northwestern University, considered by many to be the “dean in the field”, takes a pessimistic view on the prospects in his recently published magnum opus “The Rise and Fall of American Growth”.  Erik Brynjolfsson and Andrew McAfee of MIT, in contrast, argue for a more optimistic view in their recent work “The Second Machine Age” (although “optimistic” might not be the right word because of their concern for the implication of this for jobs).  They see productivity growth progressing rapidly, if not accelerating.

But such explanations are focused on possible productivity growth as dictated by what is possible technologically.  A separate factor, I would argue, is whether investment in fact takes place that makes use of the technology that is available.  And this may well be a dominant consideration when examining the change in productivity over the short and medium terms.  A technology is irrelevant if it is not incorporated into the actual production process.  And it is only incorporated into the production process via investment.

To understand productivity growth, and why it has fallen in recent decades and perhaps especially so in recent years, one must therefore also look at the investment taking place, and why it is what it is.  The rest of this blog post will do that.

B.  The Slowdown in the Pace of Investment

The first point to note is that net investment (i.e. after depreciation) has been falling in recent decades when expressed as a share of GDP, with this true for both private and public investment:

Domestic Fixed Investment, Total, Public, and Private, Net, percentage of GDP, 1951 to 2015, updated Aug 16, 2016

Total net investment has been on a clear downward trend since the mid-1960s.  Private net investment has been volatile, falling sharply with the onset of an economic downturn and then recovering.  But since the late 1970s its trend has also clearly been downward. Net private investment has been less than 3 1/2% of GDP in recent years, or less than half what it averaged between 1951 and 1980 (of over 7% of GDP).  And net public investment, while less volatile, has plummeted over time.  It averaged 3.1% of GDP between 1951 and 1968, but is only 0.5% of GDP now (as of 2015), or less than one-sixth of what it was before.

With falling net investment, the rates of growth of public and private capital stocks (fixed assets) have fallen (where 2014 is the most recent year for which the BEA has released such data):

Rate of Growth In Per Capita Net Stock of Private and Government Fixed Assets, edited, 1951 to 2014

Indeed, expressed in per capita terms, the stock of public capital is now falling.  The decrepit state of our highways, bridges, and other public infrastructure should not be a surprise.  And the stock of private capital fell each year between 2009 and 2011, with some recovery since but still at almost record low growth.

Even setting aside the recent low (or even negative) figures, the trend in the pace of growth for both public and private capital has declined since the mid-1960s.  Why might this be?

C.  Why Has Investment Slowed?

The answer is simple and clear for pubic capital.  Conservative politicians, in both the US Congress and in many states, have forced cuts in public investment over the years to the current low levels.  For whatever reasons, whether ideological or something else, conservative politicians have insisted on cutting or even blocking much of what the United States used to invest in publicly.

Yet public, like private, investment is important to productivity.  It is not only commuters trying to get to work who spend time in traffic jams from inadequate roads, and hence face work days of not 8 1/2 hours, but rather 10 or 11 or even 12 hours (with consequent adverse impacts on their productivity).  It affects also truck drivers and repairmen, who can accomplish less on their jobs due to time spent in jams.  Or, as a consequence of inadequate public investment in computer technology, a greater number of public sector workers are required than otherwise, in jobs ranging from issuing driver’s licenses to enrolling people in Medicare.  Inadequate public investment can hold back economic productivity in many ways.

The reasons behind the fall in private investment are less obvious, but more interesting. An obvious possible cause to check is whether private profitability has fallen.  If it has, then a reduction in private investment relative to output would not be a surprise.  But this has in fact not been the case:

Rate of Return on Produced Assets, 1951 to 2015, updated

The nominal rate of return on private investment has not only been high, but also surprisingly steady over the years.  Profits are defined here as the net operating surplus of all private entities, and is taken from the national account figures of the BEA.  They are then taken as a ratio to the stock of private produced assets (fixed assets plus inventories) as of the beginning of the year.  This rate of return has varied only between 8 and 13% over the period since at least 1951, and over the last several years has been around 11%.

Many might be surprised by both this high level of profitability and its lack of volatility.  I was.  But it should be noted that the measure of profitability here, net operating surplus, is a broad measure of all the returns to capital.  It includes not only corporate profitability, but also profits of unincorporated businesses, payments of interest (on borrowed capital), and payments of rents (as on buildings). That is, this is the return on all forms of private productive capital in the economy.

The real rates of return have been more volatile, and were especially low between 1974 and 1983, when inflation was high.  They are measured here by adjusting the nominal returns for inflation, using the GDP deflator as the measure for inflation.  But this real rate of return was a good 9.6% in 2015.  That is high for a real rate of return.  It was higher than that only for one year late in the Clinton administration, and for several years between the early 1950s and the mid-1960s.  But it was never higher than 11%.  The current real rate of return on private capital is far from low.

Why then has private investment slowed, in relation to output, if profitability is as high now as it has ever been since the 1950s?  One could conceive of several possible reasons. They include:

a)  Along the lines of what Robert Gordon has argued, perhaps the underlying pace of technological progress has slowed, and thus there is less of an incentive to undertake new investments (since the returns to replacing old capital with new capital will be less).  The rate of growth of capital then slows, and this keeps up profitability (as the capital becomes more scarce relative to output) even as the attractiveness of new investment diminishes.

b)  Conservatives might argue that the reduced pace of investment could be due to increased governmental regulations, which makes investment more difficult and raises its cost.  This might be difficult to reconcile with the rate of return on capital nonetheless remaining high, but in principle could be if one argues that the slower pace of new investment keeps up profitability as capital then becomes more scarce relative to output. But note that this argument would require that the increased burden of regulation began during the Reagan years in the early 1980s (when the share of private investment in GDP first started to slow – see the chart above), and built up steadily since then through both Republican and Democratic administrations.  It would not be something that started only recently under Obama.

c)  One could also argue that the reduced investment might be a consequence of “Baumol’s Cost Disease”.  This was discussed in earlier posts on this blog, both for overall government spending and for government investment in infrastructure specifically.  As discussed in those posts, Baumol’s Cost Disease explains why activities where productivity growth may be relatively more difficult to achieve than in other activities, will see their relative costs increase over time.  Construction is an example, where productivity growth has been historically more difficult to achieve than has been the case in manufacturing.  Thus the cost of investing, both public and private, relative to the cost of other items will increase over time.  This can then also be a possible explanation of slowing new investment, with that slower investment then keeping profitability up due to increasing scarcity of capital.

One problem with each of the possible explanations described above is that they all depend on capital investments becoming less attractive than before, either due to higher costs or due to reduced prospective return.  If such factors were indeed critical, one would need to take into account also the effect of taxes on investment returns.  And such taxes have been cut sharply over this same period.  As discussed in an earlier blog post, taxes on corporate profits, for example, are taxed now at an effective rate of less than 20%, based on what is actually paid after all the legal deductions and credits are included.  And this tax rate has fallen steadily over time.  The current 20% rate is less than half the effective rate that applied in the 1950s and 1960s, when the effective rate averaged almost 45%.  And the tax rate on long-term capital gains, as would apply to returns on capital to individuals, fell from a peak of just below 40% in the mid-1970s to just 15% following the Bush II tax cuts and to 20% since 2013.

Such sharp cuts in taxes on profits implies that the after-tax rate of return on assets has risen sharply (the before-tax rate of return, shown on the chart above, has been flat).  Yet despite this, private investment has fallen steadily since the early 1980s as a share of GDP.

Such explanations for the reason behind the fall in private investment since the early 1980s are therefore questionable.  However, the purpose of this blog post is not to debate this. Economists are good at coming up with models, possibly convoluted, which can explain things ex post.  Several could apply here.

Rather, I would suggest that there might be an alternative explanation for why private investment has been declining.  While consistent with basic economics, I have not seen it before.  This explanation focuses on the stagnant real wages seen since the early 1980s, and the impact this would have on whether or not to invest.

D.  The Impact of Low Real Wages

Real wages have stagnated in the US since the early 1980s, as has been discussed in earlier posts on this blog (see in particular this post).  The chart below, updated to the most recent figures available, compares the real median wage since 1979 (the earliest year available for this data series) to real GDP per worker employed:

Real GDP per Worker versus Real Median Wage, 1979Q1 to 2016Q2, rev

Real median wages have been flat overall:  Just 3% higher in 2016 than what they were 37 years before.  But real GDP per worker is almost 60% higher over this same period.  This has critically important implications for both private investment and for productivity growth. To sum up in one line the discussion that will follow below, there is less and less reason to invest in new, productivity enhancing, capital, if labor is available at a stagnant real wage that has changed little in 37 years.

Traditional economics, as commonly taught, would find it difficult to explain the observed stagnation in real wages while productivity has risen (even if at a slower pace than before). A core result taught in microeconomics is that in “perfectly competitive” markets, labor will be paid the value of its marginal product.  One would not then see a divergence such as that seen in this chart between growth in productivity and a lack of growth in the real wage.

(The more careful observers among the readers of this post might note that the productivity curve shown here is for average productivity, and not the marginal productivity of an extra worker.  This is true.  Marginal productivity for the economy as a whole cannot be easily observed, nor indeed even be well defined.  However, one should note that the average productivity curve, as shown here, is rising over time.  This can only happen if marginal productivity on new investments are above average productivity at any point in time.  For other reasons, the real average wage would not rise permanently above average productivity (there would be an “adding-up” problem otherwise), but the theory would still predict a rise in the real wage with the increase in observed productivity.)

There are, however, clear reasons why workers might not be paid the value of their marginal product in the real world.  As noted, the theory applies in markets that are assumed to be perfectly competitive, and there are many reasons why this is not the case in the world we live in.  Perfect competition assumes that both parties to the transaction (the workers and employers) have complete information on not only the opportunities available in the market and on the abilities of the individual worker, but also that there are no costs to switching to an alternative worker or employer.  If there is a job on the other side of the country that would pay the individual worker a bit more, then the theory assumes the worker will switch to it.  But there are, of course, significant costs to moving to the other side of the country.  Furthermore, there will be uncertainty on what the abilities of any individual worker will be, so employers will normally seek to keep the workers they already have to fill their needs (as they know what these workers can do), than take a risk on a largely unknown new worker who might be willing to work for a lower wage.

For these and other reasons, labor markets are not perfectly competitive, and one should not then be surprised to find workers are not being paid the value of their marginal product.  But there is also an important factor coming from the macroeconomy. Microeconomics assumes that all resources, including labor resources, are being fully employed.  But unemployment exists and is often substantial.  Additional workers can then be hired at the current wage, without a need for the firm to raise that wage.  And that will hold whether or not the productivity of those workers has risen.

In such an environment, when unemployment is substantial one should not be surprised to find a divergence between growth in productivity and growth in the real wage.  And while there have of course been sharp fluctuations arising from the business cycle in the rate of unemployment from year to year, the simple average in the rate since 1979 has been 6.4%.  This is well in excess of what is normally considered the full employment rate of unemployment (of 5% or less).  Macro policy (both fiscal and monetary) has not done a very good job in most of the years since 1979 in ensuring there is sufficient demand in the aggregate in the economy to allow all workers who want to be employed in fact to be employed.

In such an environment, of workers being available for hire at a stagnant real wage which over time diverges more and more from their productivity, consider the investment decision a private firm faces.  Suppose they see a market opportunity and can sell more. To produce more, they have two options.  They can hire more labor to work with their existing plant and equipment to produce more, or they can invest in new plant and equipment.  If they choose the latter, they can produce more with fewer workers than they would otherwise need at the new level of production.  There will be more output per unit of labor input, or put another way, productivity will rise if the latter option is chosen.

But in an economy where labor is available at a flat real wage that has not changed in decades, the best choice will often simply be to hire more labor.  The labor is cheap.  New investment has a cost, and if the cost of the alternative (hire more labor) is low enough, then it is more profitable for the firm simply to hire more labor.  Productivity in such a case will then not go up, and may indeed even go down.  But this could be the economically wise choice, if labor is cheap enough.

Viewed in this way, one can see that the interpretation of many conservatives on the relationship between productivity growth and the real wage has it backwards.  Real wages have not been stagnant because productivity growth has been slow.  Labor productivity since 1979 has grown by a cumulative 60%, while real median wages have been basically flat.

Rather, the causation may well be going the other way.  Stagnant and low real wages have led to less and less of an incentive for private firms to invest.  And such a cut-back is precisely what we saw in the chart above on private (as well as public) investment as a share of GDP.  With less investment, the pace of productivity growth has then slowed.

As a reflection of this confusion, conservatives have denounced any effort to raise wages, asserting that if this is done, jobs will be lost as firms choose instead to invest and automate.  They assert that raising the minimum wage, which is currently lower in real terms than what it was when Harry Truman was president, would lead to minimum wage workers losing their jobs.  As a former CEO of McDonalds put it in a widely cited news report from last May, a $15 minimum wage would lead to “a job loss like you can’t believe.”   Fast food outlets like McDonalds would then find it better to invest in robotic arms to bag the french fries, he said, rather than hire workers to do this.

This is true.  The confusion comes from the widespread presumption that this is necessarily bad.  Outlets like McDonalds would then require fewer workers, but they would still need workers (including to operate the robotic arms), and those workers would be more productive.  They could be paid more, and would be if the minimum wage is raised.

The error in the argument comes from the presumption that the workers being employed at the current minimum wage of $7.25 an hour do not and can not possess the skills needed to be employed in some other job.  There is no reason to believe this to be the case.  There was no problem with ensuring workers could be fully employed at a minimum wage which in real terms was higher in 1950, when Harry Truman was president, than what it is now.  And average worker productivity is 2.4 times higher now than what it was then.

Ensuring full employment in the economy as a whole is not a responsibility of private business.  Rather, it is a government responsibility.  Fiscal and monetary policy need to be managed so that labor markets are tight enough to ensure all workers who want a job can get a job, while not so tight at to lead to inflation.

Following the economic collapse at the end of the Bush administration in 2008, monetary policy did all it could to try to ensure sufficient aggregate demand in the economy (interest rates were held at or close to zero).  But monetary policy alone will not be enough when the economy collapsed as far as it did in 2008.  It needs to be complemented by supportive fiscal policy.  While there was the initial stimulus package of Obama which was critical to stabilizing the economy, it did not go far enough and was allowed to run out. And government spending from 2010 was then cut, acting as a drag which kept the pace of recovery slow.  The economy has only in the past year returned to close to full employment.  It is not a coincidence that real wages are finally starting to rise (as seen in the chart above).

E.  Conclusion

Productivity growth is key in any economy.  Over the long run, living standards can only improve if productivity does.  Hence there is reason to be concerned with the slower pace of productivity growth seen since the early 1980s, and especially in recent years.

Investment, both public and private, is what leads to productivity growth, but the pace of investment has slowed since the levels seen in the 1950s and 60s.  The cause of the decline in public investment is clear:  Conservative politicians have slowed or even blocked public investment.  The result is obvious in our public infrastructure:  It is overused, under-maintained, and often an embarrassment.

The cause of the slowdown in private investment is less obvious, but equally important. First, one cannot blame a decline in private investment on a fall in profitability:  Profitability is higher now than it has been in all but one year since the mid-1960s.

Rather, one needs to recognize that the incentive to invest in productivity enhancing tools will not be there (or not there to the same extent) if labor can be hired at a wage that has stagnated for decades, and which over time became lower and lower relative to existing productivity.  It then makes more sense for firms to hire more workers with their existing stock of capital and other equipment, rather than invest in new, productivity enhancing, capital.  And this is what we have observed:  Workers are being hired, but productivity is not growing.

An argument is often made that if firms did indeed invest in capital and equipment that would raise productivity, that workers would then lose their jobs.  This is actually true by definition:  If productivity is higher, then the firm needs fewer workers per unit of output than they would otherwise.  But whether more workers would be employed in the economy as a whole does not depend on the actions of any individual firm, but rather on whether fiscal and monetary policy is managed to ensure full employment.

That is, it is the investment decisions of private firms which determine whether productivity will grow or not.  It is the macro management decisions of government which determine whether workers will be fully employed or not.

To put this bluntly, and in simplistic “bumper sticker” type terms, one could say that private businesses are not job creators, but rather job destroyers.  And that is fine.  Higher productivity means that a firm needs fewer workers to produce what they make than would otherwise have been needed, and this is important for ensuring efficiency.  As a necessary complement to this, however, it is the actions of government, through its fiscal and monetary policies, which “creates” jobs by managing aggregate demand to ensure all workers who want to be employed, are employed.

Bernie Sanders and His $27 Average Campaign Donation

Sanders $27 Money

Bernie Sanders is certainly to be commended for leading a modern US political campaign funded almost in its entirety by campaign contributions from individuals.  According to the Center for Responsive Politics, the Sanders campaign (through June 30) raised $226 million in individual contributions, with this accounting for 99% of the total money raised by or for the campaign (including outside groups).  This is impressive, and hopefully will serve as a model for future political campaigns.

Famously, the Sanders campaign touted that the average contribution came out to just $27, thus highlighting the grass roots nature of his support.  And this has been widely quoted.  Even President Obama got in on this.  In his remarks at this year’s White House Correspondents’ Dinner, he noted:

“What an election season.  For example, we’ve got the bright new face of the Democratic Party here tonight  –-  Mr. Bernie Sanders!   There he is  —  Bernie! Bernie, you look like a million bucks.  Or to put it in terms you’ll understand, you look like 37,000 donations of 27 dollars each!”

But listening to Sanders’ speech to the Democratic Convention on Monday, a point bothered me.  And being a numbers person, I had to look it up.  Sanders noted right at the beginning of his remarks that he wanted to:

“thank the 2 1/2 million Americans who helped fund our campaign with an unprecedented 8 million individual campaign contributions – averaging $27 a piece.”

This was the first time I realized that the $27 individual contribution may not be referring to what an average person contributed, but rather to what the average donation was, where they are counting separately each donation from an individual contributor making multiple donations.

And it does appear that this is the case.  The $226 million figure noted above for total contributions divided by 8 million individual campaign contributions comes to a bit over $28 per contribution – close enough to the $27 number; it is within round-off.  But per individual, it comes to over $90 per person over the 2 1/2 million individuals who contributed to the Sanders campaign.  On average, each donor contributed 3.2 times.

This is a quibble, to be sure.  But an average contribution of $90 (per donor) does not sound as democratic as $27 (per donation).

Strong Employment Growth Has Continued, But Must Eventually Level Off

Cumul Private Job Growth from Inauguration to June 2016

Cumul Govt Job Growth from Inauguration to June 2016

A.  Introduction

A pair of recent news releases on the job market underscore what has been a strong record on job growth during Obama’s tenure as president.  On July 8, the Bureau of Labor Statistics released its monthly employment report, while on July 14, the Department of Labor issued its regular weekly report on initial claims for unemployment insurance.  The reports show continued strong growth in employment, an unemployment rate that remains below 5%, and initial claims for unemployment insurance that are at a record low as a ratio to total employment.

This blog post will review these developments, with comparisons to the outcomes seen under recent Republican presidents.  Obama’s policies have been criticized as harmful to labor by “killing” jobs through over-regulation or by the extension of health insurance under the Affordable Care Act (Obamacare), but this is simply not true.  Employment growth has been strong, and the unemployment rate is now at a level which is at, or close to, full employment levels.  It might be able to go a bit lower, but not by much.

And because unemployment cannot go much lower, job growth going forward will necessarily slow down.  When one is at full employment, job growth cannot be greater than growth in the labor force, and growth in the labor force is primarily determined by demographic factors.  While there can be month to month fluctuations, as the number choosing to enter or remain in the labor force can fluctuate (and there will be statistical variation as well, as these figures are all based on surveys), these fluctuations will even out over time as they are fluctuations around a relatively steady long-term trend (see this earlier blog post for a discussion).

This blog post will review these figures on employment growth during Obama’s tenure, and what might now be expected going forward.

B.  Job Growth, the Unemployment Rate, and Initial Claims for Unemployment Insurance

The charts at the top of this post show growth in the number of jobs, separately for private jobs and for government jobs, cumulatively from the month of inauguration for Obama and similarly for George W. Bush.

Private job growth has been strong and remarkably steady under Obama since the trough reached at start of 2010, one year after he took office.  During his first year in office, Obama’s stimulus program plus aggressive Fed actions succeeded in turning around an economy that was in full collapse as he took office.  There have been 14.8 million new private jobs gained since that turnaround.  The contrast with Bush is stark.  Private job growth under Bush was not only less in absolute amount, but also collapsed in his final year in office as the economy went into free fall following the bursting of the housing bubble.

Also in contrast to Bush (and every other recent president), government jobs have fallen during Obama’s tenure, with 460,000 less now than when he took office.  Total jobs have not grown because of additions to the public sector payroll:  There are fewer government jobs now than when Obama was inaugurated.

With the overall job growth, unemployment has fallen steadily, from a peak of 10.0% in October 2009 to just 4.9% now:

Unemployment Rates - Obama vs Reagan, up to June 2016Furthermore the unemployment rate has been at 5.0% or below since October 2015. With full employment traditionally viewed as an unemployment rate of around 5% (there is always some friction in the market), the unemployment rate cannot go much below where it is now.  And the unemployment rate is well below what it was when Reagan was in office, at the same point in their respective administrations.

Finally, the weekly report on initial claims for unemployment insurance (issued by a different unit within the Department of Labor) shows claims are now at a record low level when measured as a ratio to number employed:

Weekly Initial Claims for Unemployment Insurance as a Ratio to Employment, January 1967 to June 2016

Initial claims for unemployment insurance as a ratio to employment has never been so low since at least 1967, when the data series first began to be collected.  Indeed, it has been at a record low since late 2014.  Workers are not being laid off.

This employment record is therefore strong.  Had Mitt Romney been elected president in 2012, one can imagine what he and his party would now be saying of such a record.  In May 2012 during the campaign, Romney said that his policies would get unemployment down to 6% by the end of his first term (i.e. by January 2017).  And this was viewed as a stretch.  But it was achieved under Obama by September 2014, less than half way through his term.  And unemployment under Obama has now been at 5.0% or less since October 2015.

C.  What to Expect Going Forward

While job growth has been strong under Obama, one must also be aware that this cannot go on forever.  A slowdown has to occur.  While jobs can be (and should be) added quickly when unemployment is high, so that the unemployed can gain jobs, once one is at or close to full employment, this has to slow down.  When this happens, it should not be a surprise.

When an economy is at full employment, the growth in the number of those employed can only rise with growth in the labor force.  And this depends primarily on demographic factors.  While there can be short term fluctuations (including fluctuations in the figures arising from the statistical estimates, as they are based on surveys of households), these will even out over time.

Since the trough reached in February 2010, total employment has increased by 14.4 million, while private employment has increased by 14.8 million (government jobs have been reduced).  The average increase per month over this period was 190,000 for total employment and close to 195,000 per month for private employment.  These are also not far different for the monthly averages of just the past 12 months, of 204,000 for total employment and 194,000 for private employment.

But this cannot continue.  The labor force is growing at a pace of only 0.5% per year, based on the growth over the decade of June 2006 (when unemployment was 4.6%) to June 2016 (when unemployment was 4.9%).  Applied to the current labor force of 158.9 million, growth of 0.5% per year comes to 66,200 additional workers per month.  The pace of job growth will have to fall at some point in the not too distant future to about one-third the pace it has averaged over the last year.

A couple of caveats should be noted.  First, the rate of unemployment compatible with full employment is not known with certainty, and may well have varied over time.  The unemployment rate might fall below 5%, and was indeed in the range of 3.8 to 4.1% during the last year of the Clinton administration.  Should it be possible to bring the “full employment” rate of unemployment down by a further 1% point over the course of, say, one year (i.e. from the current 4.9% to 3.9%), then monthly job growth over that year could average 200,000 per month.  An additional 1% of the current labor force of 159 million would obtain jobs (1% of 159 million equals 1.6 million, or 133,333 per month over 12 months, plus the trend growth of the labor force of 0.5% per year adds 66,200).  But there is still a limit, and while it might not be reached immediately, it is not far off.

Separately, the number in the population that choose to participate in the labor force has varied over time, and could conceivably go higher.  Some analysts have indeed argued that it is exceptionally low right now, and can be expected to go higher as the economy returns to full employment and “discouraged workers” start again to seek jobs.  But again, there are limits to this, and as I argued in an earlier blog post, I do not see that one should expect a sharp increase.  Indeed, the long term trend has followed a steady and predictable path in recent decades (when one separates out the male and female rates), and the male and female rates have both been going downward since the late 1990s.  On top of this, the aging of the baby boomers into their normal retirement age means one should expect even slower growth in the labor force over the next ten years than over the last ten years.

Finally, this slowdown in the pace of job growth is what one should expect under ideal conditions, of an economy that is at, and then remains at, full employment levels.  Under such conditions, the pace of job growth could average only around 66,000 per month. But the economic expansion under Obama has now been underway for seven full years.  Only three other business cycle expansions have lasted so long in US history.  Eventually, every expansion has come to an end, and when it does, jobs will decline.  The expansion under Obama has continued, but who knows what will happen once a new president takes office next January.

D.  Conclusion

The jobs record under Obama has been exceptionally strong.  There is no basis for the assertions made by political opponents that his regulatory and other policies have harmed job growth.  Faced with an economy in free fall when he took office, Obama was able to engineer a stabilization and then recovery that has brought employment back to full employment levels.

This is not to deny that there are important economic issues.  Most importantly, wages have been flat and income distribution has continued to worsen.  Furthermore, with the economy now at or close to full employment, the pace of job growth up to now will have to slow in the not too distant future.  When it does, one should not be surprised.

Taxes to Pay for Highways: A Switch from the Tax on Gallons of Fuel Burned to a Tax on Miles Driven Would Be Stupid

Impact of Switching from Fuel Tax on Gallons Burned to Tax on Miles Driven

A.  Introduction

According to a recent report in the Washington Post, a significant and increasing number of state public officials and politicians are advocating for a change in the tax system the US uses to support highway building and maintenance.  The current system is based on a tax on gallons of fuel burned, and the proposed new system would be based on the number of miles a car is driven.  At least four East Coast states are proposing pilots on how this might be done, some West Coast states have already launched pilots, and states are applying for federal grants to consider the change.  There is indeed even a lobbying group based in Washington now advocating it:  The Mileage-Based User Fee Alliance.

There is no question that the current federal gas tax of 18.4 cents per gallon of gasoline is woefully inadequate.  It was last changed in 1993, 23 years ago, and has been kept constant in nominal terms ever since.  With general prices (based on the CPI) now 65% higher, 18.4 cents now will only buy 11.2 cents at the prices of 1993, a decline of close to 40%.  As a result, the Highway Trust Fund is terribly underfunded, and with all the politics involved in trying to find other sources of funding, our highways are in terrible shape. Basic maintenance is simply not being done.

An obvious solution would be simply to raise the gas tax back at least to where it was before in real terms.  Based on where the tax was when last set in 1993 and on the CPI for inflation since then, this would be 30.3 cents per gallon now, an increase of 11.9 cents from the current 18.4 cents per gallon.  Going back even further, the gasoline tax was set at 4 cents per gallon in 1959, to fund the construction of the then new Interstate Highway system (as well as for general highway maintenance).  Adjusting for inflation, that tax would be 32.7 cents per gallon now.  Also, looking at what the tax would need to be to fund adequately the Highway Trust Fund, a Congressional Budget Office report issued in 2014 estimated that a 10 to 15 cent increase (hence 28.4 cents to 33.4 cents per gallon) would be needed (based on projections through 2024).

These fuel tax figures are all similar.  Note also that while some are arguing that the Highway Trust Fund is underfunded because cars are now more fuel efficient than before, this is not the case.  Simply bringing the tax rate back in real terms to where it was before (30.3 cents based on the 1993 level or 32.7 cents based on the 1959 level) would bring the rate to within the 28.4 to 33.4 cents range that the CBO estimates is needed to fully fund the Highway Trust Fund.  The problem is not fuel efficiency, but rather the refusal to adjust the per gallon tax rate for inflation.

But Congress has refused to approve any such increase.  Anti-tax hardliners simply refuse to consider what they view as an increase in taxes, even though the measure would simply bring them back in real terms to where they were before.  And it is not even true that the general population is against an increase in the gas tax.  According to a poll sponsored by the Mineta Transportation Institute (a transportation think tank based at San Jose State University in California), 75% of those polled would support an immediate increase in the gas tax of 10 cents a gallon if the funds are dedicated to maintenance of our streets, roads, and highways (see the video clip embedded in the Washington Post article, starting at minute 3:00).

In the face of this refusal by Congress, some officials are advocating for a change in the tax, from a tax per gallon of fuel burned to a new tax per mile each car is driven.  While I do not see how this would address the opposition of the anti-tax politicians (this would indeed be a totally new tax, not an adjustment in the old tax to keep it from falling in real terms), there appears to be a belief among some that this would be accepted.

But even if such a new tax were viewed as politically possible, it would be an incredibly bad public policy move to replace the current tax on fuel burned with such a tax on miles driven.  It would in essence be a tax on fuel efficiency, with major distributional (as well as other) consequences, favoring those who buy gas guzzlers.  And as it would encourage the purchase of heavy gas guzzlers (relative to the policy now in place), it would also lead to more than proportional damage to our roads, meaning that road conditions would deteriorate further rather than improve.

This blog post will discuss why such consequences would follow.  To keep things simple, it will focus on the tax on gasoline (which I will sometimes simply referred to as gas, or as fuel).  There are similar, but separate taxes, on diesel and other fuels, and their levels should be adjusted proportionally with any adjustment for gasoline.  There is also the issue of the appropriate taxes to be paid by trucks and other heavy commercial vehicles.  That is an important, but separate, issue, and is not addressed here.

B.  The Proposed Switch Would Penalize Fuel Efficient Vehicles

The reports indicate that the policy being considered would impose a tax of perhaps 1.5 cents per mile driven in substitution for the current federal tax of 18.4 cents per gallon of gas burned (states have their own fuel taxes in addition, with these varying across states). For the calculations here I will take the 1.5 cent figure as the basis for the comparisons, even though no specific figure is as yet set.

First of all, it should be noted that at the current miles driven in the country and the average fuel economy of the stock of cars being driven, a tax of 1.5 cents per mile would raise substantially more in taxes than the current 18.4 cents per gallon of gas.  That is, at these rates, there would be a substantial tax increase.

Using figures for 2014, the average fuel efficiency (in miles per gallon) of the light duty fleet of motor vehicles in the US was 21.4 miles per gallon, and the average miles driven per driver was 13,476 miles.  At a tax of 1.5 cents per mile driven, the average driver would pay $202.14 (= $.015 x 13,476) in such taxes per year.  With an average fuel economy of 21.4 mpg, such a driver would burn 629.7 gallons per year, and at the current fuel tax of 18.4 cents per gallon, is now paying $115.87 (= $.184 x 629.7) in gas taxes per year. Hence the tax would rise by almost 75% ($202.14 / $115.87).  A 75% increase would be equivalent to raising the fuel tax from the current 18.4 cents to a rate of 32.1 cents per gallon.  While higher tax revenues are indeed needed, why a tax on miles driven would be acceptable to tax opponents while an increase in the tax per gallon of fuel burned is not, is not clear.

But the real reason to be opposed to a switch in the tax to miles driven is the impact it would have on incentives.  Taxes matter, and affect how people behave.  And a tax on miles driven would act, in comparison to the current tax on gallons of fuel burned, as a tax on fuel efficiency.

The chart at the top of this post shows how the tax paid would vary across cars of different fuel efficiencies.  It would be a simple linear relationship.  Assuming a switch from the current 18.4 cents per gallon of fuel burned to a new tax of 1.5 cents per mile driven, a driver of a highly fuel efficient car that gets 50 miles per gallon would see their tax increase by over 300%!  A driver of a car getting the average nation-wide fuel efficiency of 21.4 miles per gallon would see their tax increase by 75%, as noted above (and as reflected in the chart).  In contrast, someone driving a gas guzzler getting only 12 miles per gallon or less, would see their taxes in fact fall!  They would end up paying less under such a new system based on miles driven than they do now based on gallons of fuel burned.  Drivers of luxury sports cars or giant SUVs could well end up paying less than before, even with rates set such that taxes on average would rise by 75%.

Changing the tax structure in this way would, with all else equal, encourage drivers to switch from buying fuel efficient cars to cars that burn more gas.  There are, of course, many reasons why someone buys the car that they do, and fuel efficiency is only one.  But at the margin, changing the basis for the tax to support highway building and maintenance from a tax per gallon to a tax on miles driven would be an incentive to buy less fuel efficient cars.

C.  Other Problems

The change to a tax on miles driven from the tax on gallons of fuel burned would have a number of adverse effects:

a)  A Tax on Fuel Efficiency:  As noted above, this would become basically a tax on fuel efficiency.  More fuel efficient cars would pay higher taxes relative to what they do now, and there will be less of an incentive to buy more fuel efficient cars.  There would then be less of an incentive for car manufacturers to develop the technology to improve fuel efficiency.  This is what economists call a technological externality, and we all would suffer.

b)  Heavier Vehicles Cause Far More Damage to the Roads:  Heavier cars not only get poorer gas mileage, but also tear up the roads much more, leading to greater maintenance needs and expense.  Heavier vehicles also burn more fuel, but there is a critical difference.  As a general rule, vehicles burn fuel in proportion with their weight: A vehicle that weighs twice as much will burn approximately twice as much fuel.  Hence such a vehicle will pay twice as much in fuel taxes (when such taxes are in cents per gallon) per mile driven.

However, the heavier vehicle also cause more damage to the road over time, leading to greater maintenance needs.  And it will not simply be twice as much damage.  A careful early study found that the amount of damage from a heavier vehicle increases not in direct proportion to its weight, but rather approximately according to the fourth power of the ratio of the weights.  That is, a vehicle that weighs twice as much (for the same number of axles distributing the weight) will cause damage equal to 2 to the fourth power (=16) times as much as the lighter vehicle.  Hence if they were to pay taxes proportionate to the damage they do, a vehicle that is twice as heavy should pay 16 times more in taxes, not simply twice as much.

(Note that some now argue that the 2 to the fourth power figure found before might be an over-estimate, and that the relationship might be more like 2 to the third power.  But this would still imply that a vehicle that weighs twice as much does 8 times the damage (2 to the third power = 8).  The heavier vehicle still accounts for a grossly disproportionate share of damage to the roads.)

A tax that is set based on miles driven would tax heavy and light vehicles the same.  This is the opposite of what should be done:  Heavy vehicles cause far more damage to the roads than light vehicles do.  Encouraging heavy, fuel-thirsty, vehicles by switching from a tax per gallon of fuel burned to a tax per mile driven will lead to more road damage, and proportionately far more cost than what would be collected in highway taxes to pay for repair of that damage.

c)  Impact on Greenhouse Gases:  One also wants to promote fuel efficiency because of the impact on greenhouse gases, and hence global warming, from the burning of fuels. By basic chemistry, carbon dioxide (CO2) is a direct product of fuel that is burned.  The more fuel that is burned, the more CO2 will go up into the air and then trap heat. Economists have long argued that the most efficient way to address the issue of greenhouse gases being emitted would be to tax them in proportion to the damage they do.  A tax on gallons of fuel that are burned will do this, while a tax on miles driven (and hence independent of the fuel efficiency of the vehicle) will not.

An interesting question is what level of gasoline tax would do this.  That is, what would the level of fuel tax need to be, for that tax to match the damage being done through the associated emission of CO2.  The EPA has come up with estimates of what the social cost of such carbon emissions are (and see here for a somewhat more technical discussion of its estimates).  Unfortunately, given the uncertainties in any such calculations, as well as uncertainty on what the social discount rate should be (needed to discount costs arising in the future that follow from emitting greenhouse gases today), the cost range is quite broad. Hence the EPA presents figures for the social cost of emitting CO2 using expected values at alternative social discount rates of 2.5%, 3%, and 5%, as well as from a measure of the statistical distribution of one of them (the 95th percentile for the 3% discount rate, meaning there is only an estimated 5% chance that the cost will be higher than this).  The resulting costs per metric ton of CO2 emitted then range from a low of $11 for the expected value (the 50th percentile) at the 5% discount rate, $36 at the expected value for the 3% discount rate, and $56 for the expected value for the 2.5% discount rate, to $105 for the 95th percentile at a 3% discount rate (all for 2015).

With such range in social costs, one should be cautious in the interpretation of any one. But it may still be of interest to calculate how this would translate into a tax on gasoline burned by automobiles, to see if the resulting tax is “in the ballpark” of what our fuel taxes are or should be.  Every gallon of gasoline burned emits 19.64 pounds of CO2.  There are 2,204.62 pounds in a metric ton, so one gallon of gas burned emits 0.00891 metric tons of CO2.  At the middle social cost of $36 per metric ton of CO2 emitted (the expected value for the 3% social discount rate scenario), this implies that a fuel tax of 32.1 cents per gallon should be imposed.  This is surprisingly almost precisely the fuel tax figure that all the other calculations suggest is warranted.

d)  One Could Impose a Similar Tax on Electric Cars:  One of the arguments of the advocates of a switch from taxes on fuel burned to miles driven is that as cars have become more fuel efficient, they pay less (per mile driven) in fuel taxes.  This is true.  But as generally lighter vehicles (one of the main ways to improve fuel economy) they also cause proportionately far less road damage, as discussed above.

There is also an increasing share of electric, battery-powered, cars, which burn no fossil fuel at all.  At least they do not burn fossil fuels directly, as the electricity they need to recharge their batteries come from the power grid, where fossil fuels dominate.  But this is still close to a non-issue, as the share of electric cars among the vehicles on US roads is still tiny.  However, the share will grow over time (at least one hopes).  If the share does become significant, how will the cost of building and maintaining roads be covered and fairly shared?

The issue could then be addressed quite simply.  And one would want to do this in a way that rewards efficiency (as different electric cars have different efficiencies in the mileage they get for a given charge of electricity) rather than penalize it.  One could do this by installing on all electric cars a simple meter that keeps track of how much it receives in power charges (in kilowatt-hours) over say a year.  At an annual safety inspection or license renewal, one would then pay a tax based on that measure of power used over the year.  Such a meter would likely have a trivial cost, of perhaps a few dollars.

Note that the amounts involved to be collected would not be large.  According to the 2016 EPA Automobile Fuel Economy Guide (see page 5), all-electric cars being sold in the US have fuel efficiencies (in miles per gallon equivalent) of over 100 mpg, and as high as 124 mpg.  These are on the order of five times the 21.4 average mpg of the US auto stock, for which we calculated that the average tax to be paid would be $202.  Even ignoring that the electric cars will likely be driven for fewer miles per year than the average car (due to their shorter range), the tax per year commensurate with their fuel economy would be roughly $40.  This is not much.  It is also not unreasonable as electric cars are kept quite light (given the limits of battery technology) and hence do little road damage.

e)  There Are Even Worse Policies That Have Been Proposed:  As discussed above, there are many reasons why a switch from a tax on fuel burned to miles driven would be a bad policy change.  But it should be acknowledged that some have proposed even worse. One example is the idea that there should be a fixed annual tax per registered car that would fund what is needed for highway building and maintenance.  Some states in fact do this now.

The amounts involved are not huge.  As was calculated above, at the current federal gasoline tax of 18.4 cents per gallon, the driver of a car that gets the average mileage (of 21.4 mpg) for the average distance a year (of 13,476 miles) will pay $115.87 a year.  If the fuel tax were raised to 32.1 cents per gallon (or equivalently, if there were a tax of 1.5 cents per mile driven), the average tax paid would be still just $202.14 per year.  These are not huge amounts.  One could pay them as part of an annual license renewal.

But the tax structured in this way would then be the same for a driver who drives a fuel efficient car or a gas guzzler.  And it would be the same for a driver who drives only a few miles each year, or who drives far more than the average each year.  The driver of a heavy gas guzzler, or one who drives more miles each year than others, does more damage to the roads and should pay more to the fund that repairs such damage and develops new road capacity.  The tax should reflect the costs they are imposing on society, and a fixed annual fee does not.

f)  The Cost of Tax Collection Needs to be Recognized:  Finally, one needs to recognize that it will cost something to collect the taxes.  This cost will be especially high for a tax on miles driven.

The current system, of a tax on fuel burned, is efficient and costs next to nothing to collect.  It can be charged at the point where the gasoline and other fuels leaves in bulk from the refinery, as all of it will eventually be burned.  While the consumer ultimately pays for the tax when they pump their gas, the price being charged at the pump simply reflects the tax that had been charged at an earlier stage.

In contrast, a tax on miles driven would need to be worked out at the level of each individual car.  And if the tax is to include shares that are allocating to different states, the equipment will need to keep track of which states the car is being driven in.  As the Washington Post article on a possible tax on miles driven describes, experiments are underway on different ways this might be done.  All would require special equipment to be installed, with a GPS-based system commonly considered.

Such special equipment would have a cost, both up-front for the initial equipment and then recurrent if there is some regular reporting to the center (perhaps monthly) of miles driven.  No one knows right now what such a system might cost if it were in mass use, but one could easily imagine that a GPS tracking and reporting system might cost on the order of $100 up front, and then several dollars a month for reporting.  This would be a significant share of a tax collection that would generate an average of just $202 per driver each year.

There is also the concern that any type of GPS system would allow the overseers to spy on where the car was driven.  While this might well be too alarmist, and there would certainly be promises that this would not be done, some might not be comforted by such promises.

D.  Conclusion

While one should always consider whether given policies can be changed for the better, one needs also to recognize that often the changes proposed would make things worse rather than better.  Switching the primary source of funding for highway building and maintenance from a tax on fuel burned to a tax on miles driven is one example.  It would be a stupid move.

There is no doubt that the current federal tax on gasoline of 18.4 cents per gallon is too low.  The result is insufficient revenues for the Highway Trust Fund, and we end up with insufficient road capacity and roads that are terribly maintained.

What I was surprised by in the research for this blog post was finding that a wide range of signals all pointed to a similar figure for what the gasoline tax should be. Specifically:

  1. The 1959 gas tax of 4 cents per gallon in terms of current prices would be 32.7 cents per gallon;
  2. The 1993 gas tax of 18.4 cents per gallon in terms of current prices would be 30.3 cents per gallon;
  3. The proposal of a 1.5 cent tax per mile driven would be equivalent (given current average car mileage and the average miles driven per year) to 32.1 cents per gallon;
  4. The tax to offset the social cost of greenhouse gas emissions from burning fuel would be (at a 3% social discount rate) 32.1 cents per gallon.
  5. The Congressional Budget Office projected that the gasoline tax needed to fully fund the Highway Trust Fund would be in the range of 28.4 to 33.4 cents per gallon.

All these point in the same direction.  The tax on gasoline should be adjusted to between 30 and 33 cents per gallon, and then indexed for inflation.

Don’t Blame a Lack of Job Growth on the Free Trade Agreements

Jobs in the Motor Vehicle Sector, 1967 to 2014, ver 2


June 20, 2016:  This is a slightly revised version of the original post, where the blue curve on the chart above has now been drawn to show solely the impact of productivity growth, rather than productivity growth and net import growth combined.  This is simply for clarity, and the points made all remain the same.  There was then minor editing of the text to reflect this new presentation. 

A.  Introduction

It has been repeatedly said in the current US presidential campaign that the various free trade agreements the US has signed in recent decades have led to a decimation of jobs in manufacturing.  And it has been largely left unchallenged.  The assertion has come not only from Donald Trump on the right (the expected Republican nominee, as the other candidates have dropped out), but also from Senator Bernie Sanders on the left.  And it has been made so often, and without a response from others, that many might well believe it to be true.  It is presented as something obvious and spoken of as “everyone knows …”.

But it is not true.  First of all, the assertion itself is confused on many levels.  If it were true that never negotiating a free trade agreement would have led to millions of more jobs than would have been the case without the trade agreements, who would have filled those jobs if the economy is at, or close to, full employment?  Second, the whole point of trading is that there will be shifts across sectors.  There may be a decline in production in a sector where imports will rise, but there will then also be a rise in production in a sector where exports will grow.  While this might not be fully off-setting, to leave out any such offset is a mistake.

But if one ignores such higher level issues, what might have happened to jobs in just one sector if imports were somehow cut off by raising trade barriers?  The prime example most often cited is the US auto industry.  This blog post will look at what has in fact happened to jobs in the sector in recent decades, what the impact would have been had there been no imports, and what happened as a result of productivity growth.

The bottom line is that even under generous assumptions of what would have happened if imports had been restricted, such cuts in imports would not have had a very big impact on jobs in the sector.  Rather, jobs in the auto industry have been largely flat over the past half century not because of imports, but because productivity has increased.  And productivity growth is a good thing.

B.  Jobs in the US Motor Vehicle Sector, and the Impact of Imports

The chart at the top of this post shows (as the curve in black) what has happened to US jobs in the motor vehicle sector since 1967.  The data comes from the US Bureau of Economic Analysis, as part of its National Income and Product Accounts (NIPA), and covers the period from 1967 (the first year in this data series) to 2014 (the most recent year with job figures).  “Jobs” are defined as the number of persons engaged in production in the sector, counted in terms of full time equivalent employees and including any self-employed in the sector.  The sector is Motor Vehicles, and includes vehicle bodies, trailers, and parts.

The number of jobs in the sector was largely flat over much of the period, fluctuating generally in the range of 0.9 to 1.3 million, but somewhat less over the last decade (a consequence of the 2008 collapse of the economy and then slow recovery).  The number of jobs in the sector fell from 1,057,000 in 1967 to 872,000 in 2014, a fall of 17%.

[Technical note on the jobs data:  The BEA changed its categorization of jobs in this sector in 2000, and only provided overlapping data for the three years 1998 to 2000 for both the new and old definitions.  For the period prior to 1998, I rescaled the jobs figures to reflect the average proportional change shown in the 1998 to 2000 figures.  Strictly speaking, the earlier data is not directly comparable to the figures from 1998 onwards, but for the purposes here, the approximation is adequate.]

What would the number of jobs have been had imports been cut off?  While many things would likely change as a result of policy measures that somehow ended all imports (and would depend on precisely what measures were taken), a generous set of assumptions to make would be that all that was previously imported would now be made domestically, and that despite what would likely be higher costs, total sales from the sector would nonetheless remain unchanged.  We will make those assumptions, and also assume that average productivity would remain unchanged.  And imports will be measured by net imports, i.e. gross imports minus gross exports of the sector, as cutting off all imports would likely lead to exports from the sector being similarly cut.

Under such assumptions, the number of jobs in the sector would be as shown in the red curve on the chart at the top of this post.  By construction, there would be more jobs in the sector, as sales and productivity would be unchanged but all the production would now be domestic.  But not only would the result be a relatively modest increase in jobs in any given year, the absolute number of jobs would also be flat over the period as a whole. The number of jobs in the sector would be 1.1 million after rounding in 1967 and still 1.1 million in 2014 (although with fluctuations in the intervening years).

Cutting off imports would not have led to a big growth in jobs in the auto sector over this period.  It would not even have led to a modest growth over the period as a whole.

C.  The Impact of Productivity Growth

If not imports, why then has employment in the sector largely been unchanged for most of this close to half century, and indeed declined by 17% from the start to end points? Output grew by a lot.  Motor vehicle sector domestic output in 2014 was 4.5 times higher than what it was in 1967 (in real terms).  Yet employment was less.

The reason, of course, is productivity growth.  One needs far fewer workers now to build a car than what was needed in 1967.  There has been widespread growth in the use of robotics to substitute for many in the traditional production line, as well as other measures to reduce the number of workers needed to make each car.  The result is that output per worker (productivity) was 5.4 times higher in 2014 than what it was in 1967 (in real terms), based on the BEA figures.  Hence the number of workers needed and employed fell from the 1,057,000 in 1967 to 872,000 in 2014 (the same ratio, within roundoff, as the ratio of 5.4 to 4.5).

What if this productivity growth had not occurred?  If costs and sales had remained the same as otherwise (not likely, but assume that for the purposes here), one would then have needed a sharp increase in the number of workers to produce in 2014 what could be produced with the productivity of 1967.  The number of workers that would then have been needed is shown as the blue curve (the top one) in the chart above.

With no productivity growth, but all else the same as otherwise, one would have had to employ far more workers in the sector to produce the autos and other motor vehicles sold. Put another way, the reason there has been no growth in the number of jobs in the sector over the last half century is not because of imports, but because of productivity growth. The impact of imports, even under generous assumptions, has been minor in comparison.

And productivity growth is a good thing, not a bad.  For real incomes to improve, productivity must go up, not stagnate.  There are, however and most certainly, important issues with how the gains to that productivity growth is being distributed.  As earlier posts on this blog have discussed, median real wages have been basically stagnant since around 1980, and the gains to growth since around 1980 have gone fully to the extremely rich.

What might be done about this maldistribution of the gains to productivity growth is an extremely important, but separate, issue.  That is where the policy debate should focus.  A set of measures that might be taken to address the sharp increase in inequality in the decades since Reagan was president was discussed in this earlier post on this blog. Limiting imports is not one of them.  The most important measure for the issues here would be active fiscal policy to keep the demand for labor at close to full employment levels.  Only then will labor have the bargaining power needed to ensure wages rise in line with productivity growth.

D.  Conclusion

Free trade agreements signed by the US in recent decades have been harshly criticized in this year’s presidential campaign, by candidates both on the right (Donald Trump) and on the left (Bernie Sanders).  They take as a given that the agreements have led to a huge loss of jobs in the sectors where trade is possible.  But that is simply not the case.  The auto sector is often taken as the pre-eminent example of how American industry has been harmed by exposure to competition from imports.  But as discussed above, even under extreme assumptions on what would follow if imports were cut off, the impact on jobs would be small.  Rather, the reason there are not more jobs in the sector now than there were in 1967 is because the productivity per worker is now much higher.  And higher productivity is a good thing.

This is not to say that there are are no possible issues with the trade agreements.  There are.  But the concern I have is not with measures that move towards free (or at least freer) trade, but rather with measures that will do the opposite.  For example, a problem with the Trans-Pacific Partnership (negotiated between the US and 11 other Pacific rim countries, but which is still to be ratified or not by Congress), is the provision that would extend the patent protection enjoyed by US pharmaceutical companies to the 11 other countries, thus constraining their access to generic drugs.  This is the creation of a trade impediment, not a move towards freer trade.

But it is incorrect to blame the free trade agreements signed in recent decades for the lack of job growth in sectors such as autos.  Jobs in that sector have been flat or declining because worker productivity is now much higher than it was before.  One needs fewer workers to make each car.  There are certainly issues, extremely important issues, with how the gains to that productivity growth have been distributed, but restricting imports would not address them.