Notes on Productivity, Mark-Ups, and a Bold Response

This post will hopefully illuminate some common threads in my recent reading and writing. In "Productivity Growth and Real Interest Rates in the Long Run", Kurt Lunsford of the Cleveland Fed, considers negative interest rates in a context of long term productivity growth. He writes:

The results of this Commentary suggest that low productivity growth is not driving persistently negative real interest rates. The results also indicate that an upward shift in productivity growth will not necessarily lead to higher real interest rates. Finally, the results suggest that low productivity growth does not condemn the economy to low or negative real interest rates.

Even though low productivity growth doesn't necessarily condemn the economy to lower interest rates, the Fed's best approach to productivity issues, is to make certain its commitments for monetary representation are fully honoured, for all participants. Otherwise, central bankers can inadvertently contribute to needless destruction in wealth generating potential. In particular, today's (unfortunate) interest rate targeting shouldn't include Fed second guessing, as to whether existing marketplace circumstance could diminish aggregate capacity. (Especially if private sector participants become anxious to take action, which I'll explain towards the end of this post.)

Indeed, a level nominal target would not only prevent such second guessing, it would lessen the Fed's arbitrary impact on economic forecasts, and make it more likely that the natural interest rate finally turns positive. Interest rate targeting of late, includes too many judgement calls, as to whether real economy factors will worsen productivity by generating less aggregate output, in relation to aggregate input.

I've written frequently regarding services as a drag on productivity, but in some respects, services are nonetheless associated with productivity gains. For instance, Stephen Broadberry has documented services productivity in terms of organizational capacity changes:

The key to achieving high productivity was the "industrialisation" of market services, which involved the adoption of high-volume, low-margin methods to produce industrialised or mass market services.  The uneven spread of industrialised services across sectors and across countries explains the shifting comparative productivity performance of Britain, the United States and Germany.

"The Social Transformation of American Medicine" was - in many respects - a documentation of the numerous occasions when physicians resisted services industrialisation. Did the physicians' preferences for autonomy, stand in the way of productivity gains?

Our desire for personal autonomy is not the real problem for productivity, because this preference is intricately connected to how we perceive our relationships with others in all aspects of our lives. Time based product is experiential, in ways which go beyond the practical necessities of knowledge based product. However, personal autonomy can unfortunately encourage widespread price making, as opposed to the price taking that is (informally and spontaneously) suggested by the marketplace for group coordination. Only recall that price making, from a production standpoint, increases the amount of input that is necessary, before output is possible. Which means it's lousy both in terms of economic progress, and the ways in which societies coordinate mutually desired activities over the long run.

Mark-ups are just one example of the problems which arise re price making. George Lundberg, M.D. (and editor of JAMA) in "Severed Trust: Why American Medicine Hasn't Been Fixed" (2000), noted the problem of mark-ups when he wrote:

I had to do one test at a time, and the cost was passed on at a fairly high rate for those days. The hospital charged five dollars for one blood sugar analysis. Then automation entered the laboratories in the late 1950s and early 1960s. The first major instrument was the Autoanalyzer...This instrument revolutionized the chemical lab business by making it possible to load multiple serum samples from patients into the machine and to run through one after another without any handling by humans. So what happened to the price? It stayed the same. The hospital continued to charge five dollars per test even though one person, running the machine, could do fifty in the time it used to take to do one. Why did the hospital continue to charge five dollars? Because it could get it.

Standard practice now may require blood sample analysis every hour, and sometimes instantaneously. I knew many pathologists who received a percentage of all the income coming into hospital labs...Many other medical procedures have a similar pricing history. Changes are initially high because of the labor-intensive nature of developing new procedures. The coronary artery bypass operation provides a perfect example. The surgeons who pioneered the procedure spent a lot of time and money on research and development. They spent many hours in laboratories, working with animal models, to perfect the technique. The time they spent with their first patients also was intensive. Everything was new, and it all required close monitoring and attention. The total cost for the new procedure exceeded $60,000 - a reasonable price considering the investment that had gone into it.

But then more and more surgeons learned the procedure, often in the course of their regular residency training. They had no research and development costs, and their patients did not need to be so intensively monitored. In fact, the bypass operation now is the most common in hospitals, but the charges haven't moderated in many places...Over and over again in the medical marketplace, a new commodity is introduced, high prices are charged because the commodity is rare, but the prices are maintained even when the commodity is commonplace. Why does this happen? Because the patients do not know any better, the insurance companies let it happen, and the purchasers do not care or are hoodwinked. This is how the costs of care in this country have gotten out of control.

Consider these markups in a context of aggregate productivity, where input demands in excess of output potential, have macroeconomic effects. In "Aggregate productivity and the rise of mark-ups", the authors note that average mark-ups in the U.S. have been increasing over the last 20 years, which in turn has coincided with slowing productivity. They add:

Mark-ups increase firm's prices and reduces their production. A high average mark-up reduces output and depresses the demand for labour and capital, generating low aggregate employment and low aggregate investment. It reduces the aggregate labour and capital shares, and increases the aggregate profit share. In fact, increasing average mark-ups has been proposed as an important cause for the declining participation rate, the slow recovery, the weakness of investment, the decline in interest rates, and the declining labour share in the US economy.

However, the level of average mark-up does not, by itself, affect aggregate productivity. Instead, aggregate productivity depends on the heterogeneity of mark-ups across firms. From a social perspective, low-mark-up firms are too large and high mark-up firms are too small. This inefficiency in the allocation of resources across firms, reduces aggregate productivity.

Baqaee and Farhi expressed that "low-mark-up firms are too large". Might this mean that recent healthcare mergers will choose the option of lower mark-ups, as political intransigence is unexpectedly being parlayed into private action? This is what healthcare providers have actively fought off for as long as many can remember. Perhaps autonomy would not have been lost to hierarchy, had individuals and institutions not turned the gains of high-volume low-margin methods among providers, into high-margin final product for healthcare consumers.

Mark-ups. Who could resist them, while they were there for the taking, and so many individuals and organizations had the autonomy to do so. Of course the cumulative effects of countless "lucky" price makers, has doubtless contributed to recent government cutbacks in healthcare. Yet it remains to be seen how these mergers on the part of healthcare providers, will affect actual marketplace dimensions. Will we get more output, with less input - meaning, more productivity? Only time will tell.