Worst productivity drop ever means more inflation

(MENAFN-Asia Times)

Inflation in July was “only” 8.5% year-on-year compared to 9.1% year-on-year in June, mainly because energy prices fell over the month. Hoping that lower inflation would slow the Federal Reserve’s monetary tightening, the yield on 30-year US Treasury bonds fell – for about 10 minutes.

Traders decided that the light at the end of the tunnel was likely the headlamp of the oncoming express, and the yield on 30-year bonds retreated.

A close look at the numbers suggests that the resurgence of inflation is far from under control. Rent inflation, according to the Bureau of Labor Statistics, is increasing at an annual rate of 6.1%. The Zillow Rental Cost Index, based on actual transactions on its website, shows rent inflation of 15% at the end of June.

The worst decline in labor productivity on record in the second quarter of 2022, meanwhile, points to persistent, long-term inflation. Output per man-hour in the non-farm business sector fell 2.2% year on year. Think of it as the economic equivalent of long Covid.

We haven’t seen a decline in labor productivity of this magnitude since the 1970s, during the last major wave of inflation.

Productivity is the ultimate arbiter of the price level. In the short term, a flood of demand created by the government can drive up the price level. The US government’s $6 trillion stimulus package after the 2022 Covid recession has driven prices up, exacerbated by supply factors. A global shortage of semiconductors has reduced automotive production, environmental regulations have suppressed domestic power generation in the United States, and Covid has disrupted logistics globally.

After stimulating demand with a $6 trillion expansion of its balance sheet, the Federal Reserve is now stifling demand by raising interest rates. This will certainly have an impact on prices, but it does not solve the much bigger problem. After years of underinvestment in plant and equipment, worker training and infrastructure, the United States is facing a decline in productivity. Businesses cannot get enough additional production for each new increase in labor.

The cause of the drop in productivity is not difficult to diagnose. American companies do not invest. US orders for non-military capital goods (excluding transport) are lower in real terms than they were in 2016 (and have not started to catch up after their collapse in 2020).

The Federal Reserve today tries to operate with one leg. The Great Inflation of the 1970s ended with a two-pronged approach: monetary restrictions to reduce inflation and tax cuts to encourage investment.

Additionally, the federal government in the late 1970s and early 1980s spent 1.2% of GDP on federal R&D, funding the invention of the digital age. Income and capital gains tax cuts prompted entrepreneurs to bet on these new technologies, creating the longest peacetime expansion in American history.

“Supply-side economics,” the Reagan administration’s watchword, meant that producing more goods more efficiently was the cure for inflation, not just monetary policy. Today, the supply side of the US economy is deteriorating, not improving.

The Biden administration’s $52 billion subsidy for domestic chip production has a reasonable justification on national security grounds, but it will do nothing for American productivity. It doesn’t matter to General Motors whether it buys chips made in Taiwan or Texas. As long as US productivity lags, inflation will persist.

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