Deregulation is boosting productivity, which boosts wages

Recent data releases have put to bed, for now, the narrative that the U.S. economy is on the precipice of recession. They also affirm that the current economic expansion will go down in the history books as the longest period of growth the U.S. economy has ever experienced.

I remain a bit skeptical of data whose collection was interrupted by the partial federal government shutdown, but taken at face value the news has been good.

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One recent bit of good news was the data on productivity of nonfarm workers released by the Bureau of Labor Statistics. The release showed that in the first quarter of 2019 labor productivity, or output per hour worked, increased by 3.6 percent at an annual rate.

This was the second-largest quarterly increase in the recovery to date, if you exclude the first few quarters immediately following the end of the recession as productivity typically surges as the economy exits a recession.

The year-over-year gains in productivity were strong as well, coming in at 2.4 percent — the largest gain since the third quarter of 2010. 

Productivity is an essential component of economic growth and for wage and salary growth, which for much of this recovery has been tepid.

Since the mid-2000s, productivity has been in a bit of a slump in the U.S., and this has been both a source of concern and a puzzle for economists (a similar puzzle emerged in the 1970s.) 

Various explanations have been proffered to explain the slump in productivity, including measurement error in our macroeconomic data or demographic factors.

The demographic explanation hinges on the share of younger workers in the economy who have less human capital and are therefore less productive than their older counterparts.

There is another factor, one that gets far less scrutiny that can help explain both these productivity puzzles and perhaps the recent surge in productivity: regulation.

Economic models are generally simplifications from the complexity of the economy at large, but they are nonetheless useful for understanding economic concepts.

One example of such a model that is used to study general equilibrium and welfare theorems in economics is the Robinson Crusoe economy.

The Robinson Crusoe model is an island economy where the sole resident, Mr. Crusoe, is both producer (of coconuts) and consumer. Productivity on the island would be measured by the number of coconuts harvested per hour and output as the total number of coconuts produced.

What factors might impact productivity on the island? 

The demographic explanation would suggest that as Crusoe gains experience and human capital and becomes better at climbing the trees and harvesting the coconuts, his productivity would rise.

If Crusoe were provided with a boom lift that he could drive from tree to tree, his productivity would increase as a result of this investment and even more so if the lift were equipped with a GPS device that could guide him directly to the trees that are ready for harvest.

But what if a regulatory agency were added to this island economy? Suppose that this new agency, call it the Coconut Farming Protection Bureau (CFPB), was formed with the goal of making coconut markets work for consumers, responsible providers and the economy as a whole. 

Suppose the bureau then issued two new regulations for the coconut industry aimed at protecting the sustainability of the island’s coconut grove and the other at protecting the endangered Macaroon Loon that builds its nests in the coconut palms. 

The first rule requires Crusoe to measure and document the size of each coconut before it is harvested and the second requires documentation that any tree that is being harvested does not have a Macaroon Loon nesting in it.

Without debating the virtue of the CFPB goals to protect the coconut industry and the Macaroon Loon, what impact would such regulation have on the output of the island economy and the productivity of Crusoe?

Because he would have to spend a portion of each hour he would normally use harvesting coconuts on compliance with the new regulations, both the output of the economy, the total number of coconuts harvested, and his productivity, the number of coconuts harvest per hour, would fall.

Regulations are not implemented in a vacuum; they have real impacts on the economy, and this fact can help us understand historical productivity puzzles and perhaps the recent jump in productivity.

In the 1970s, there were 43,198 pages added to the Code of Federal Regulations, and from 2000 to 2016, 50,121 additional pages were added, bringing the total number of pages to over 185,000 in 2016.

The pace of regulation has slowed significantly in the Trump administration thus far. The total number of economically significant regulations to date is the lowest of any administration since Reagan during the same point in those administrations.

Investment in equipment has also been a factor. The average annual growth rate of investment spending on equipment during 2015-2016 was just 0.35 percent, but during 207-2018, it jumped to 7.7 percent, which helps our workers' productivity and raises GDP growth.

Reduced regulatory burdens and more equipment appear to be boosting both output and productivity in the U.S.

It may be a bit premature to pop the champagne corks in celebration of the end of the productivity slump, but if you like pina coladas there is a good chance that more coconuts will be coming your way.

Sean Snaith is a professor and the director of the University of Central Florida’s Institute for Economic Forecasting and a nationally recognized economist in the field of business and economic forecasting.