The higher effort hypothesis

An unexpected connection to economic growth and technology.

In my first post, I said that U.S employment had fallen since 2000 because of higher job search costs and in turn, the reason for higher job search costs is because of the higher effort levels being demanded of workers by employers.

How plausible is this hypothesis? One reason to doubt it would be because if firms have the power to demand more effort from workers, why didn't they do so before 2000?

This is a reasonable objection. However, we can provide existence proof that effort levels do indeed fluctuate and that is by looking at how worker productivity varies with the business cycle.

For both the 2001 and 2008 - 2009 recessions, labor productivity surged higher. In the 2008 recession productivity grew by 5.5% from Q4 2008 to Q4 2009. This is about 4% higher than the normal rate of productivity growth during this period.

Can there be any other explanation for such a sharp increase in productivity other than higher effort levels? One factor is that in the preceding 12 months productivity growth was zero as firms hoarded labor in the expectation that weak demand would not persist - incorrectly of course, as output would then go on to fall precipitously over the next 12 months.

A second factor is that the composition of workers changed as workers in lower productivity sectors saw greater employment falls than higher productivity sectors. But this can only account for perhaps one percentage point of that 3.5% increase. The upshot is that effort levels still increased by about 1.5 percent from Q42008 to Q42009.

We can ask again, why do effort levels rise? If firms have the power to make workers work harder during recessions, why haven't they already used that power before a recession?

The obvious answer is during recessions unemployment rises, workers worry more about being laid off and thus work harder to avoid that outcome. However, this can't be the complete explanation. Otherwise, employers could lay off some workers, the remaining workers would work harder, resulting in firms being able to cut more staff, leading to even greater effort increases on the part of workers and so on ad infinitum. It would also imply that levels of effort and unemployment could change independently of economic output - something that we do not see.

We need to bring a second ingredient into the mix. What else happens when worker effort levels rise? Quality of work declines. Workers make mistakes more often under higher pressure, and interactions with these workers become less pleasant for customers.

Why do customers put up with this kind of service? During recessions, people are poorer and look to save money by switching to cheaper and lower quality goods and services. Higher effort levels allow firms to cut payrolls and thus costs. Firms, therefore, are simply giving consumers what they want.

Does this mean that the cause of the increase in effort between 2000 and 2020 is because people are less wealthy? Note that income in 2020 is about 25% higher than 2000 levels. This doesn't seem like a promising line of thought. However, suppose people are not as wealthy as that 25% figure would imply.

After all, it has long been understood that a person's current income does not necessarily reflect their wealth or determine their current consumption. This is because what matters for spending is how much income someone can expect to earn during their entire lifetime. One can have low or no income but still spend at a high rate, on the assumption that one's income will be higher in the future.

Back in 2000, economic growth was far higher than in 2020. Productivity growth had been around 2.5% over the previous five years. Twenty years later, in contrast, productivity growth averaged just 1.2% between 2015 and 2020.

Thus people in 2020 were, if not actually poorer than in 2000, certainly not 25% richer either.

Still, if households were richer in 2020 than they were in 2000, why the shift to lower quality goods and services?

One can also ask, if wealth is this all-important factor, wouldn't that mean that as you go backward in time from 2000, to 1995 or 1990 and so on - when both output and economic growth were lower, you should see higher effort levels and higher job search costs than in 2000?

Let's simplify things a bit first and suppose that post-2000, wealth actually drops, so that in 2005 people were only as wealthy as they were in 1995.

Would people, in that case, go back to buying 1995 era goods? No flat-screen TVs, broadband routers, or Blackberry phones; instead it's back to the cathode ray display, dial-up connection, and feature phone.

Though new technology is more expensive it offers dramatic gains in performance and quality. We can therefore assume consumers will want to grab hold of as many new goods as they can. But to afford these new goods they must make savings elsewhere: this can be opting for lower quality versions of goods that haven't been directly improved by technology, or lower quality services, which is where the shift to higher effort comes into play.

So what really matters is not wealth per se, but the race between wealth and the advancement of technology. Normally there is no tension between technological progress and an increase in wealth. But when the growth rate - or the expected growth rate slows down - then people can feel substantially poorer even if technology continues to advance.

Demographics can also negatively affect wealth levels. Longer lifespans lead to longer retirements and require households to have more savings to maintain a given standard of living. Aging populations mean more retirees have to be supported by fewer workers. This results in retirees receiving less money from workers (via pension schemes) or each worker must be taxed more heavily to support the larger number of retirees. Either way, society is poorer off.

To maintain consumption levels in retirement, households can save more while working. If invested by firms, these savings will result in higher economic output and a greater amount of household assets. But note that households are not actually wealthier because these funds are needed to maintain consumption levels, not increase them.

However, regardless of whether firms invest these savings, effort levels rise. Why?

If firms don't invest more then households are simply poorer, the level of wealth diminishes, but technology does not regress - no one wants to bid for 1G phones on eBay - so effort levels ultimately rise.

Now if firms do invest households' savings then wealth levels are preserved but the higher investment will also result in the creation of new goods. Whenever technology progresses more than wealth, effort levels rise.

Does it even matter whether firms invest the additional savings from households? If they do so, then households will not be poorer, the higher investment will advance technology further, but not all of that investment will go toward the creation of new goods. A portion of it will go toward reducing the cost of producing existing goods as well as improving existing goods. Whether or not higher investment ultimately leads to lower effort levels depends on the relative size of these portions.

So if firms were to increase their investment it might help the labor market, but certainly not nearly enough to restore the 2000 status quo. Other, more direct, interventions into the labor market would be required for that to happen.

Addendum:

What I wrote above isn’t quite correct. It’s not the “stock” of new goods that matters when it comes to the shift to lower quality goods, but the overall stock of goods. The continued creation of new goods post-2000 has led to the stock of overall goods increasing faster than wealth. Or equivalently the ratio of wealth to consumption/income has fallen.