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PENSIONS LO 5/23 REVISE Copy The Region Research Digest longevity products such as life insur- ance and annuities, not health prod- ucts, account for nearly all the reduction. Better guidance would clearly help. Indeed, to demonstrate, the economists provide an example (see sidebar on page 45) that shows how advisers and households can use deltas to shape an optimal portfolio. Getting specific The economists are quite pointed in their recommendations both to insurance companies and to house- hold advisers. Companies, say the economists, should report health Edward Prescott Ellen McGrattan and mortality delta for the insurance products they offer. And financial advisers “should guide households Unmeasured Investment on the optimal exposure to health Ellen McGrattan and Edward Prescott discuss and mortality delta over the life how intangible capital may explain rising labor cycle, based on their preferences and productivity during economic downturns characteristics.” This guidance should lead to improved decision making by households and better offerings from companies. “We hope or much of the period after World War II, changes in labor that the introduction of these risk F productivity were a useful gauge of how well the U.S. economy measures will facilitate standardiza- was faring; workers produced more goods and services per hour tion, identify overlap … identify during booms than they did during recessions. In fact, economic risks that are not insured by existing output and labor productivity—the ratio of gross domestic product products, and ultimately lead to new to hours worked—often moved in synchrony as the nation’s eco- product development.” nomic fortunes waxed and waned. But since the mid-1980s the two —Douglas Clement measures have become less correlated over the business cycle; dur- ing the Great Recession, labor productivity increased even as GDP plummeted. This statistical disconnect has led some researchers to question real business cycle theory—the idea that cyclical fluctuations in the JUNE 2012 46 The Region Research Digest economy are driven in large part by shocks to the productivity of Predicted real per capita business investments, 2004–2011 capital and labor. (To be more pre- (Relative to a 1.9% geometric trend in real per capita GDP) cise, shocks that are nonmone- 120 tary—that is, unrelated to changes in money supply.) If, according to 110 RBC models of aggregate decisions by households and firms, such 100 shocks typically cut output more than hours worked during down- 90 turns, how could labor productivi- ty have risen as GDP fell during 80 the last recession? Tangible Recent research by Ellen 70 Intangible McGrattan and Edward Prescott, Trend Relative Index, to Minneapolis Fed monetary advisers 60 and economists at the University of Minnesota and Arizona State 50 University, respectively, suggests 40 that the divergent paths of GDP and 2004 2005 2006 2007 2008 2009 2010 2011 labor productivity during the down- turn and at other times in recent decades isn’t as strange as it seems— Quantifying the intangible December 2005 Region, online at and that eulogies for existing RBC minneapolisfed.org.) Intangible capital consists of assets aggregate theory are premature. For McGrattan and Prescott, that can’t be touched and are diffi- In “The Labor Productivity two leading proponents of the use cult to measure—spending on Puzzle” (Minneapolis Fed Working of quantitative, dynamic business things such as research and devel- Paper 694, online at minneapolis- cycle modeling to analyze macro- opment, marketing and worker fed.org), McGrattan and Prescott economic trends, including intangi- training that add value to a compa- find that when established theory ble capital investment in total ny but are usually reported as includes intangible capital, it accu- economic output is the key to expenses rather than as capital rately predicts the behavior of the making sense of head-scratching investment. As such, most invest- actual U.S. economy. Investment countercyclical movements in labor ment in intangible capital is not in intangible capital is a type of productivity over the past 25 years. included in GDP, part of the business investment that isn’t The economists theorized that national accounts kept by the fed- counted in the standard measure labor productivity as measured by eral government. (For further of labor productivity (GDP divid- national accounts might not give a background on intangible capital, ed by hours worked in the market complete picture of the dynamics sector). see “The Untouchables” in the 47 JUNE 2012 The Region Research Digest of production and labor in a cycli- ation of tangible goods and servic- significantly during the recent cal economy. Would productivity es counted in GDP. recession—a finding consistent with trends during the last depressed The 2008 financial crisis plays established aggregate theory based period look different if intangible no role in the simulation, because on the neoclassical model of eco- investment as well as tangible the investigators chose to focus on nomic growth. Thus, McGrattan investments such as new buildings nonmonetary (or “real”) shocks and Prescott’s experiment solves the and equipment were counted in rather than disruptions that could labor productivity puzzle by recon- official government measures of be attributed to monetary policy, ciling the apparent mismatch total economic output? By not tighter credit or other financial between theory and economic data including intangible investment in factors that impede investment. that show labor productivity buck- GDP, government figures may “We wanted to see what happens if ing the GDP trend. “The addition underestimate the fall in total, or you don’t have the usual financial of intangible capital and non- true, economic output during a factors in there—not one word neutral technology to the model downturn—and therefore true about banks, the Federal Reserve, was crucial in accounting for high labor productivity (total output the collapse of Lehman Brothers, productivity and low GDP during divided by total hours worked) et cetera,” McGrattan said. the period,” they write. may decline rather than increase. So in the real economy, did “Fewer and fewer people are Not so puzzling after all intangible investment fall during arguing that [intangible invest- The economists assumed that the downturn? Economists and ments] are negligible,” McGrattan shocks in their model were large statisticians struggle to measure said in an interview. “And if intan- enough to produce changes in intangible capital directly. But gible investments are declining like GDP and hours worked compara- McGrattan and Prescott note that tangible investments in a recession, ble with economic data, but didn’t R&D investment and advertising then there really isn’t much of a try to match observations on busi- spending—important components puzzle in terms of labor productiv- ness tangible investment. It turns of intangible investment—both ity movements.” out that the shocks had a dramatic declined sharply relative to their To test their theory, McGrattan impact on business investment long-term trends after 2008. and Prescott developed a model decisions during the economic As for evidence of negative economy in which shocks to the downturn; in the model, both tan- shocks curbing capital formation production efficiency of businesses gible and intangible investment fell and other economic activity during affect the output of goods, services by about half before starting to the downturn, the economists and new intangible capital. A key recover (see chart on page 47). point to costs incurred by businesses assumption of the model is that The sharp drop in intangible to comply with increased federal these shocks are “nonneutral”; that investment contributes to a decline regulation, including tightened is, changes in productivity due to in actual economic output greater financial rules and environmental factors such as technological inno- than that measured by official gov- standards. Federal regulatory vation and government regulation ernment GDP accounts. This implies spending and employment increased affect the creation of new intangi- that in the actual U.S. economy, after 2007, while GDP declined. ble capital differently from the cre- true labor productivity declined —Phil Davies JUNE 2012 48.
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