One down! What does Harberger mean by mushrooms and yeast and by Real Cost Reduction? How does Oulton’s method compare to those of Harberger?

If you find a typo or spelling mistake stay schtum. I don’t want to know. Enjoy the wonders of grwoth accounting. With thanks to Chris for pointing me towards Disney, Haskel and Heden.

Early economic theory implied that capital accumulation was the main determinant of economic growth (Helpman 2004, pp 9-18). However, since Solow’s (1957) investigation of the components of growth and the discovery of a significant residual unexplained by increases in the input of capital, land or labour, other theories have become necessary. Subsequent research showed this residual to be composed of a combination of aggregate Total Factor Productivity and economic reallocation between different industries (Oulton and Srinivasan 2005 pg 13). Total Factor Productivity is thus a major determinant of economic performance. Paul Krugman, characteristically pithily, explains; productivity “isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker” (1992, pg 2).

This essay will begin by contrasting the way Oulton and Harberger refer to TFP, and the implications of this. Next Harberger’s contribution to the literature will be set in context and a discussion will follow on the significance of his characterization of Real Cost Reduction and his metaphor regarding mushrooms and yeast. This will be followed by a commensurate section focusing on Oulton, which will describe how his aims impacted the methods he employed and the implications of his findings. The discussion will continue to draw comparisons between the two methods focusing on the timeframe examined, the level of aggregation and the tension between the findings. This essay will conclude by looking at historical examples in an attempt to reconcile the approaches as complementary rather than competing.

Total Factor Productivity is referred to as “Multi Factor Productivity” (MFP) by Oulton and O’Mahoney (1994 pg 1), whereas it is awarded the more lyrical designation of “Real Cost Reduction” (RCR) by Harberger (1998 pg 2). This has some bearing on the methodology applied by Outlon and Harberger. For Harberger the reference to RCR is intended locate the improvements at the firm level, and to indicate it can occur in 1001 ways. The more clinical MFP used by Oulton locates the process at the industry level and relates to a more long term process. To facilitate a comparison of analytical methods, for the purposes of this essay, I will refer to Harberger’s address at the one-hundred tenth meeting of the American Economic Association and to Oulton’s work with Srinivasan on the UK economy (2005), his book with O’Mahoney has been referred to when necessary (1994).

The two papers were written under different circumstances and the methods employed differ accordingly. Harberger is concerned with anthropomorphising the residual by placing it in the hands of an “entrepreneur or a CEO, or a production manager” (1998 pg 3), furthermore he is intent on emphasising that TFP is both additive and available from a multitude of sources (1998 pg 26). To this effect he argues that RCR should be seen as the primary determinant of the residual. To illustrate his case Harberger refers to “Mushrooms” and “Yeast”:

The analogy with yeast and mushrooms comes from the fact that yeast causes bread to expand very evenly, like a balloon being filled with air, while mushrooms have the habit of popping up, almost overnight, in a fashion that is not easy to predict (1998 pg 4).

Yeast refers to sources of TFP which influence many different sectors across the whole economy. Mushrooms refer to the advances in TFP which signal a rupture within a firm or industry after which things are done differently. Mushrooms represent the creative side of Schumpeter’s gales of Creative Destruction, as Harberger recognises himself (1998 pg 17-18).

In contrast Oulton’s 2005 paper concerns the effects of ICT on TFP growth, and a longer term view is taken to describe how ICT impacts TFP growth in different industries with the UK, and the UK economy more widely. Taking adjusted industry wide figures Oulton seeks to enhance analysis of the TFP growth associated (or not)[1] with ICT investment. The analysis which is offered by Oulton does not seek TFP growth in the exploits of CEOs or entrepreneurs, rather he examines the long run complementary investment which accompanies ICT investment and which may interfere with traditional estimations of TFP growth.

Complementary investment is expenditure on reorganisation which is necessary to accompany ICT investment because old organisational structures are often incompatible with new ICT investments (Oulton and Srinivasan 2005 43-51). This is not recorded as investment and so depresses recorded TFP growth but yields savings in future years as the new ICT friendly organisation structure remains even as ICT capital stock depreciates or becomes obsolete. Therefore, the more aggregate approach taken by Oulton allows for broader, longer term trends to be teased out of the data than is allowed by Harberger’s closer firm level focus. This impersonal approach suits ICT as it is often seen as more yeasty than other technologies as its benefits are not particularly industry specific.

A significant difference between Harberger’s and Oulton’s methods is that Harberger disaggregates his data down to the firm level where possible to enable him to point to precisely where his RCR is happening. For example, he discusses of US and Mexican TFP performance to illustrate his paper and shows that a larger amount of between industry and within industry TFP growth happens in a small number of successful firms and that some firms show negative TFP growth even as their competitors are booming (1998 4-18). That is, most TFP growth in an economy often comes from a minority of firms in a minority of industries, despite regression in some industries and some firms. In contrast Oulton looks for results at the whole industry level. With regard to the distribution of TFP growth, his findings indicate that firm level enquiry can disguise the real payoffs to “yeasty” ICT investment.

To conclude this essay will turn to a paper by Richard Disney, Jonathan Haskel and Ylva Heden which discusses the effect of the entry and exit of firms and facilities on TFP growth in the UK. They find that:

Between 1980 and 1992, entry, exit and the reallocation of market shares (what we term external effects) accounted for 50% of labour productivity growth and 80-90% of TFP growth in establishments… Between 1980 and 1992, single establish-ment firms (25% of manufacturing employment) experienced no pro-ductivity growth among survivors (2003 pg 691).

The rather startling results imply an awful lot of mushrooms and an awful lot of lemons. The firm level focus of Harberger’s analysis should be vital to any analysis following from these findings. However, the corollary to the discovery of mushrooms is not that other firms were failing. This is where Oulton’s methods complement those of Harberger, the failure to find TFP growth does not mean that it did not occur, because it is recorded as a residual, measurement is of the utmost importance, and Oulton’s work has shown that measurement error can reduce measured TFP growth. Rather than existing firms failing complementary analysis by Inklaar and Timmer (2007) indicate that “intangible investments, complementary to ICT investments” have since caused broader based and more extensive increases in TFP growth.

Bibliography

 

Disney, R., J. Haskel and Y. Heden “Restructuring and Productivity Growth in UK Manufacturing” in The Economic Journal, Vol. 113, No. 489 (Jul., 2003), pp. 666-694

 

Harberger, A. C., “A Vision of the Growth Process,” The American Economic Review, Vol. 88, No. 1 (Mar., 1998), pp. 1-32

 

Helpman, E. (2004) The Mystery of Economic Growth (USA: Harvard University Press)

 

Inklaar, R. and M. P. Timmer, Of Yeast and Mushrooms: Patterns of Industry-Level Productivity Growth, German Economic Review 8 (2007), 174-187

 

Krugman P. (1992), The Age of Diminished Expectations: US Economic Policy in the 1980s, (USA: MIT Press)

 

Oulton, N. and M. O’Mahoney, Productivity and Growth: A Study of British Industry, 1954-1986 (Cambridge University Press, 1994).

 

Oulton, N. and S. Srinivasan, “Productivity Growth in UK industries, 1970-2000: structural change and the role of ICT,” Bank of England Working paper 259 (2005)

 

Solow, R. M. “Technical Change and the Aggregate Production Function.” Review of Economics and Statistics, August 1957, 39(3), pp. 312-20

 

Solow, R. M. “We’d better watch out”, New York Times Book Review, July 12, 1987, page 36.


[1] Robert Solow infamously said “You can see the computer age everywhere but in the productivity statistics” (1987 pg 36).

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