What is productivity? (or how far could GPD drop?)

The economist JK Galbraith introduced the idea that in an affluent society such as ours, demand must be invented. While we’re all willing to work to afford food and shelter, we’re not automatically willing to trade our leisure time for a nicer watch or an expensive painting. Once our basic needs are met, companies must convince us to continue working to buy designer clothing, a sleeker phone, or front-row seats to a concert.

The frightening thing about this is just how much of the production in the US is “unnecessary.” GDP is a measure of all the goods and services produced in this country. What if we’re no longer willing to pay much for the “unnecessary” consumables? Could GDP drop by 20%? 40%?

About 71% of GDP is personal consumption, 14% is investment, and the rest is government expenditures (I’m ignoring the minor effect of imports). If consumers make a long term shift in their spending habits, there’s simply no way to make up for it. An increase in investment would just create overcapacity and more empty office buildings and closed factories. If the government tries to take up the slack from consumers and starts buying goods and services itself, it just keeps buying until it runs out of money. Keynes idea of fiscal stimulus is for the government to make up for a temporary lack of consumption. If the drop in consumption represents a permanent shift, Keynes is helpless. Another way of thinking about it is via Say’s Law. Say’s Law basically argues that supply creates its own demand as laborers are able to buy the products they produce. The classic problem is that while this argues against a general glut, there can be great dislocations between what’s produced and what’s consumed. For example, when the government subsidizes the Detroit auto industry, workers make cars that no one wants to buy. When the government throws money into inefficient infrastructure projects as Japan did, workers make trains that no one needs and bridges that no one wants. In the short-term a shift in consumption habits creates painful dislocations that result in unemployment and real wealth destruction. In the long-term, while GDP may be lower, utility (the economic measurement of happiness), is unchanged. For example, a chef’s wages contribute directly to GDP; if that chef uses all his wages to hire a nanny to take care of his kids, the nanny’s wages are also included. If that chef decides to be a stay at home dad and cook for his family instead, GDP will measure a loss of productivity, though no one is any poorer or less productive. One of the pillars of economics is that trade is good. Through specialization we all benefit and become more productive. This holds true until our specialization supports the consumption of things we no longer care about. If I’m a rolex watchmaker and you’re a designer dress maker and we each lose interest in the other’s products, the specialization no longer benefits us.

Originally published at Risk Over Reward blog and reproduced here with the author’s permission.

3 Responses to "What is productivity? (or how far could GPD drop?)"

  1. Anonymous   March 6, 2009 at 2:56 pm

    An economics newbie here. I have a layman’s understanding of this matter and also have been thinking a lot about the limits on personal consumption. If your arguments hold, then we are heading for a much deeper slump or even a full-fledged depression. If you go to any mall, you will see the nature of hyper-consumption and waste. And if there is no need for all that stuff, then, we are unlikely to get out the recession/depression anytime soon.

    • Guest   March 7, 2009 at 8:41 pm

      Newbie, You are right. Our challenge is to be happier, or at least as happy, with less stuff. That may be good for the earth and healthier but it creates lots of problems with the concepts of capital formation, taxation, etc.. We could be fully employed tending our vegetable plots and making clothes but that doesn’t fund social security or universal health care. Our big houses may sound like the old “Waltons” tv family where each member of the extended family calls out ‘goodnight’ to each other from their various rooms at bedtime.

  2. Andrew Bost   March 14, 2009 at 3:43 pm

    Everything has become too redundant in today’s society. You see the big difference between now and the great depression is technology. If this resilient economy continues down this death spiral path we are currently on then there will only be limited opportunities and only a small limited amount of time before the real wars erupt. We need to flip this country on its head. I have been thinking about this and the only solution is a GIANT RESET BUTTON which literally releases everyone. Just move, allow every family to move. There are a lot of vacant homes out there and if we give these families, that are willing to take the risk, time from creditors (6-9 months) in order to settle down, readjust and find NEW jobs. The main change would be a jolt of passion to physically start a new life. If done big enough, around the entire U.S.A, I believe people will be inspired to work harder and live better lives. The goal is to create a new physical life which would in turn completely change the attitudes of the people, which should be our # 1 priority. We are a country that loves working and loves spending, there is absolutely nothing wrong with that. This is one of the most exciting times in all of our lives, as far as new tech goes. Desiring an object and creating a goal that induces incentive is great. This is the main reason our country is so liquid. China loves it and we provide a global trading hub for the rest of the world. Give $15,000 to every family, with no option to exchange for other currencies, which is willing to do this. If everyone moves there will instantly be a HUGE demand as well as a HUGE supply for and of people across this great nation of ours. This then in turn ignites the spark of the ultimate goal. To create an ENORMOUS DEMAND FOR TRADE instantly, everywhere. Specialization would come back into the picture and GDP can continue to explode on its path to the upside. The main rule is to keep everything completely fair across the board. One problem that would arise is what to do with the current mortgages. The toxic credit of the families would be extended by the government, as well as payment history and different unilateral credit scores transferred and protected by them as well. It sounds completely crazy but I believe we need to reawaken the spirits of our fellow Americans. There is still time to turn things around but we need to remember the clock never stops ticking and we can’t stop bigger snowballs once they start. It is critical we hit the button.