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Michael Mandel has a long and excellent blog post on this question.  He claims that the supposed productivity gains were concentrated in a small number of sectors (one of which, by the way, was financial services ha-ha) and that they are mostly illusory when cross-checked with other sources of data.  Here is his final conclusion:

However, the effect of the adjustment on the 2007-2009 period is spectacular.  Productivity growth, which had been 1.6% annually in the original data, basically disappears. The decline in real GDP is twice as large  (-1.3% per year in the original data, -2.9% in the adjusted data).  And economists are no longer presented with the confounding puzzle of why unemployment rose so much with such a modest decrease in GDP–it’s because the decrease in GDP was not so modest.  (see a piece here on Okun’s Law, which links GDP changes with unemployment changes).

His redone figures, by the way, are based on the assumption that intermediate inputs are growing and shrinking roughly at the rate of final product (Mandel believes we are mismeasuring these intermediate inputs and thus finding illusory productivity gains over that period.)  Think of his alternative numbers as illustrative rather than necessarily his best estimate.  The implications of his analysis include:

1. Productivity statistics aren’t well set up to cover outsourcing.

2. Beware of measured productivity gains, reaped over short periods of time, based on supposed drastic declines in intermediate inputs.  We’re probably mismeasuring those inputs.  Mike’s examples on these points are pretty convincing, walk through what he does for instance take a look at his numbers on mining: “Mining, for example, combines a 10% drop in real gross output with an apparent 46% drop in real intermediate inputs,  leading to a reported 23% gain in real value-added and a 26% gain in productivity.  It’s very hard to understand how intermediate inputs decline four times as fast as output!”

3. During the crisis, output fell more than we thought and thus our recovery isn’t going as well as we think.  (By the way, this is the most effective critique of the ZMP hypothesis, since the implied decline in true output now comes much closer to matching the measured decline of employment.)

4. Issues of “international competitiveness” are much more important than either economists or the Obama administration have been thinking.  Excerpt:

…the mismeasurement problem obscures the growing globalization of the  U.S. economy, which may in fact be the key trend over the past ten years. Policymakers look at strong productivity growth, and think they are seeing a positive indicator about the domestic economy.  In fact, the mismeasurement problem means that the reported strong productivity growth includes some combination of domestic productivity growth, productivity growth at foreign suppliers, and productivity growth ”in the supply chain’.  That is, if U.S. companies were able to intensify the efficiency of their offshoring during the crisis,  that would show up as a gain in domestic productivity.

5. Read #4 directly above, think about who captures those gains, and you can see that the Mandel productivity hypothesis is broadly consistent with some of the data on income inequality.

6. There really is a structural unemployment problem and it stems from ongoing low productivity growth.

7. At the risk of sounding self-congratulatory, if you combine Mike’s estimates with the new Spence paper, and the reestimation for male median wages (down 28 percent since 1969), in my view the TGS thesis is looking stronger than it did even two months ago when the book was published.

Krugman writes:

But when you cut the price of everything — which is more or less what happens when wages fall across the board — there’s nothing else to substitute away from.

Yes, economics textbooks typically show a downward-sloping “aggregate demand curve”. But the reasons for that curve’s downward slope aren’t the same as for your ordinary demand curve. It’s a process that works like this: lower prices -> lower demand for money -> lower interest rates -> higher spending. And that process doesn’t operate when, as is currently the case, short-term interest rates (which are the ones that matter for money demand) are zero.

Here is more.

Yet a deflationary downward spiral is not the necessary or even the likely outcome.  Even if a liquidity trap prevents the Fed from credibly inflating to recovery, it is much harder to argue that the Fed is helpless to prevent a downward deflationary spiral.  The Fed can do that very credibly indeed.  The Fed is already doing that.  It’s credible and there is no undesired outcome, such as five or six percent inflation, which needs to be seen through ex post.

Another way to put this point is that the AD curve does not sufficiently embody the Fed’s reaction function (Larry Summers is fond of making a related observation), much less individual expectations based on that reaction function.  The model is incomplete and in this case the incompleteness really matters.

A few smaller points deserve mention:

1.Wages usually fall sequentially, not across the board and all at once, especially not in a large, decentralized, non-trade union-ruled economy such as the United States.  That creates a greater chance that an employment boost kicks in, in some sectors, before prices fall (prices are sticky too!) and thus the economy may enter a Clower-Leijonhufvud-Hutt upward spiral of employment and output.

2. Krugman’s third sentence (“It’s a process that works like this: lower prices -> lower demand for money -> lower interest rates -> higher spending.”) need not be the dominant causal mechanism when so many variables are changing.  Scott in particular might think that interest rates are not so important.

3. A different reason to be skeptical of wage cuts, as a mechanism for macroeconomic recovery, is simply that wage cuts are often small relative to threshold required rates of return for investors, especially when “wait and see” remains an option for those holding the cash.

Across the country companies are still reluctant to hire — even though they’ve been doing quite well financially.

According a report today from the Bureau of Economic Analysis, corporate profits rose 29.2 percent in 2010. That is the fastest growth in over 60 years.

That’s from Catherine Rampell.  File under “Hamlet to Horatio.”

Here is one MR reader request, from RW Rogers:

Is it true that Canadian financial institutions have been relatively unscathed by the recent worldwide economic turmoil and that they were relatively unscathed during the Great Depression? If yes, why?

The Great Depression is a straightforward story, here is an excerpt from Paul Kedrosky:

Despite being adjacent geographically and tightly connected economically, banks failed in Canada and the U.S. at very different rates. Specifically, no Canadian banks failed in the period, while more than 8,000 U.S. banks failed.

Why? Among other reasons is the different structure of the systems, with Canadian banks having a branch banking structuring, making them less tied to any specific region or customer. For their part U.S. banks in the period were larger in number but smaller in assets, with far more single-branch banks in the U.S. than in Canada (where there were virtually none). The larger branch network created resilience, not just in terms of assets but in terms of markets.

What about the noughties?  Nick Rowe makes some relevant points: Canada has fewer major banks and they are more tightly regulated, hold more capital, and housing is not encouraged so much by law.  It is harder to walk away from an underwater mortgage.  Here is Megan McArdle on Canada.  Simon Johnson explains why the Canadian model cannot work for the US.  Most significantly, the U.S. banking system is in part the Canadian banking system, not so much for deposits but for high-risk activities.  That makes Canadian banking look safer, but of course Canada as a country bears a lot of risk from when the U.S. banking system goes bad.

That is a request from Hoover.  Catherine Rampell writes:

In February, for example, just 64.2 percent of adults were either in a job or actively looking for one, representing the lowest participation rate in 25 years.

At the same link you will see evidence that the number is likely to decline.  Some women are less eager to work, some men are quitting the search for work, and there is a general aging of the population.  Fewer students work while they are in school.  Here are further links to future projections.

That’s hardly the end of work but one thing dramatic recessions can do is to reveal new pieces of information.  By overturning the table, we (sometimes) see which pieces of the puzzle did not fit in the first place.  One result of this recession is that we will revise downwards our estimate of the labor force participation rate, both current and future.

A few questions are:

1. What is the political economy of a world where so few people work?

2. What kind of low-rent areas will evolve to accommodate some of these people?

3. Will we in fact move to some form of a guaranteed annual income?

Note that the answer to #2 will affect the feasibility of #3.  And our current notion of “protecting all the old people” against major health care catastrophes may someday be seen as an anachronism.  The more progress medicine makes, the harder this will be to achieve and afford.  Feasible future equilibria all seem to involve death panels, which actually may make #3 seem more attractive, relatively speaking, than spending so much money on Medicare.  Rationally or not, once the moral principle is admitted of not giving everyone absolute protection against every extreme health care event, this may encourage a shift toward cash transfers.