Economic growth is driven by growth in the labor force and growth in productivity in the long run. Short run gains can be had by credit growth. However, if the debt gets too large, there is a painful deleveraging process where the chickens come home to roost. The best lever to pull if the policy makers want more growth is increasing productivity.
There are various factors which determine why families have kids which makes it difficult to encourage families to have more kids. Even if the government incentivized having more kids through the tax code, it may not have the desired effect of producing more growth because they might not get jobs. One way to make it easier for people to get a job is to have faster GDP growth per capita which takes us back to productivity growth.
America’s productivity growth rate was -0.2% in 2016 which is why the GDP per capita was so weak. However, America is not alone in this weakening trend.
The charts below show the average five-year productivity growth rates in various regions.
As you can see from the chart on the left, advanced economies have seen their productivity cut in less than half from the rate they were growing at in the early 2000s. An example of a developed economy would be Japan.
Emerging economies, which typically grow at faster rates than the developed world, have also had stagnant productivity growth rates since the 2008 recession. As you can see from the dotted line in the middle chart, emerging economies without China have slower productivity growth than advanced economies. China is one of the countries which still has productivity growth, although it has also decelerated quickly.
An example of an emerging economy would be India. The chart on the right shows low income developing countries which now have negative productivity growth on average over the past five years. An example of a low-income developing country would be Nigeria.
To be clear, the productivity growth rates shown in the chart above are what is called total factor productivity. This growth rate measures the growth of outputs relative to the inputs of labor and capital. It effectively measures the economy’s long term growth rate caused by technological improvements. It’s highly disconcerting to see low factor productivity growth rates in most countries as it signals a scarcity of innovation.
The main reason why productivity is decreasing across the globe is because trade growth is subdued. Free trade is the best way to improve growth worldwide and get people out of poverty. Free markets work because both trading partners determine they are better off after they do business. On a global scale, productivity allows for countries to specialize in creating the goods and services they produce the best. It increases efficiency in the economy. When a country is specializing in a task, it is the most likely to produce the best innovations. It’s like the difference between a computer scientist creating an app and a liberal arts major creating an app. Obviously, the computer scientist will produce the better app because that’s what he/she is trained to do.
The chart below shows the pause in specialization over the past decade. This a major hindrance to improving productivity growth.
As you can see from the chart below, world trade growth fell to 1.9% in 2016. The last two times trade growth fell below 2% the U.S. was in a recession. That doesn’t necessarily mean America was in a recession in 2016 since the prior two times were much lower than 2%. However, if the weakening trend continues, a recession in the near future seems probable.
The next obvious question is what is causing this slowdown in trade. There are a multitude of factors which can decelerate trade growth. One of the biggest factors is policy uncertainty. Policy uncertainty causes businesses to stop taking risks because they are worried that the rules will change.
The chart below shows a measurement of the policy uncertainty with the blue line.
The European Immigration Crisis, U.K. referendum, and the U.S. elections have been the causes of the three large boosts in policy uncertainty in the past few years. The next potential pop could be the French elections. The first round of voting is on April 23rd and the final round is on May 7th where the top two finishers in the first round face off in a head-to-head matchup.
As you can see in the chart, the orange line, which represents quarterly world merchandise imports volume, has been in a downward trend ever since the policy uncertainty started to increase.
Besides economic policy uncertainty, another hindrance to trade growth is trade restrictive measures. As you can see in the chart on the left, the number of yearly trade restrictive measures didn’t spike in the recent few years. However, as you can see in the chart on the left, the number of stockpiled trade restrictive measures have ballooned from 464 in October 2010 to 2,238 in October 2016. This may be slowing down trade growth.
The policy initiatives to improve productivity growth should focus on improving trade. The best way to improve trade would be to eliminate policy uncertainty by passing clear legislation. Secondly, barriers to entry should be eliminated which means lowering tariffs and eliminating any other trade restrictive measures such as regulations.
Productivity growth is very weak. This weakness along with low interest rates have caused a financialization of the economy. The stock market and junk market are no longer tethered to the economy as cheap credit fuels those bubbles. While the stock market’s performance may not be effected by improvements in productivity in the near term, the long term technological advancements are key to the improvement of human lives globally. The best way to get productivity back on track would be to improve global trade which has been hindered by policy uncertainty and a stockpile of trade-restrictive measures. Populist candidates, who have been winning elections lately, generally aren’t in favor of free trade which is a problem for those hoping productivity growth will be improved in the next few years.