Walter Oi and the Productivity Puzzle

Just over a year ago I wrote a post suggesting that slow productivity growth in the current recovery might have something to do with the changing demographic composition of the US labor force and the significant structural changes in the US economy following the 2008 financial crisis and downturn. Here’s how I put it last year.

I don’t deny that secular stagnation is a reasonable inference to be drawn from the persistently low increases in labor productivity during this recovery, but it does seem to me that a less depressing, though perhaps partial, explanation for low productivity growth may be available. My suggestion is that the 2008-09 downturn was associated with major sectoral shifts that caused an unusually large reallocation of labor from industries like construction and finance to other industries so that an unusually large number of workers have had to find new jobs doing work different from what they were doing previously. In many recessions, laid-off workers are either re-employed at their old jobs or find new jobs doing basically the same work that they had been doing at their old jobs. When workers transfer from one job to another similar job, there is little reason to expect a decline in their productivity after they are re-employed, but when workers are re-employed doing something very different from what they did before, a significant drop in their productivity in their new jobs is likely, though there may instances when, as workers gain new skills and experience in their new jobs, their productivity will rise rapidly.

In addition, the number of long-term unemployed (27 weeks or more) since the 2008-09 downturn has been unusually high. Workers who remain unemployed for an extended period of time tend to suffer an erosion of skills, causing their productivity to drop when they are re-employed even if they are able to find a new job in their old occupation. It seems likely that the percentage of long-term unemployed workers that switch occupations is larger than the percentage of short-term unemployed workers that switch occupations, so the unusually high rate of long-term unemployment has probably had a doubly negative effect on labor productivity.

I wrote that post trying to find some reason for optimism in the consistently dismal productivity data that have been reported since a recovery of sorts began in 2009. Unfortunately, the productivity data reported since I wrote that post last year have not improved. Job growth, until last month at any rate, has continued to be strong, while productivity growth has remained nearly anemic. Although it’s disappointing that productivity growth hasn’t picked up in the last ‘year, I haven’t totally given up hope that productivity growth could still revive.

Aside from the demographic and structural changes that I mentioned last year, there is another factor operating and also tend to hold down productivity growth when the growth in employment involves a lot of new entrants into the labor force and a lot of switching between jobs and, even more so, switching between occupations. The basic idea, developed by the great Walter Oi is that labor is a quasi-fixed factor.

From a firm’s viewpoint labor is surely a quasi-fixed factor. The largest part of total labor cost is the variable-wages bill representing payments for a flow of productive services. In addition the firms ordinarily incurs certain fixed employment costs in hiring a specific stock of workers. These fixed employment costs constitute an investment by the firms in its labor force. As such they introduce an element of capital in the use of labor. Decisions regarding the labor input can no longer be based solely on the current relation between wages and marginal value products but must also take cognizance of the future course of these quantities. The theoretical implications of labor’s fixity will be analyzed before turning to the empirical magnitude of these fixed costs.

For analytic purposes fixed employment costs can be separated into two categories called, for convenience, hiring and training costs. Hiring costs are defined as those costs that have no effect on a worker’s productivity and include outlays for recruiting, for processing payroll records, and for supplements such as unemployment compensation. These costs are closely related to the number of new workers and only indirectly related to the flow of labor’s services Training expenses, on the other hand, are investments in the human agent, specifically designed to improve a worker’s productivity.

The training activity typically entails direct money outlays as well as numerous implicit costs such as the allocation of old workers to teaching skills and rejection of unqualified workers during the training period.

So if the increase in employment during this recovery has been associated with more job and occupation switching and more new entrants into the labor force than in previous recoveries, then at least part of the deficit in productivity in this recovery relative to earlier recoveries might be accounted for. And if so, we might still expect that the rate of productivity growth will start increasing before long as the on-the-job training they have received enables the recently hired workers to improve their skills in their new jobs and occupations.


5 Responses to “Walter Oi and the Productivity Puzzle”

  1. 1 Miguel Navascués June 25, 2016 at 10:47 am

    Very interesting David, I think that it is plenty of sense.


  2. 2 john June 26, 2016 at 9:24 am

    If I have a textile factory in Massachusetts making productive workers. Then move it to South Carolina making productive workers. No change in US productivity.

    But if I move it to Taiwan the US loses productivity. Yet I still own my factory.

    What you may have in part is a measurement problem where much US productivity is located elsewhere.

    iPhone typing.


  3. 3 Tom Walker June 26, 2016 at 12:04 pm

    Please do not overlook two crucial lines in Oi’s 1962 article:

    “The central theme of this paper has been the treatment of labor as a quasi- fixed factor. This concept of labor was suggested by J. M. Clark, who dealt primarily with the social cost of unemployment [“Studies in the Economics of Overhead Costs,” Chicago: University of Chicago Press, 1923, pp. 357-85].”

    Oi’s argument means something completely different in the context of Clark’s framework. Clark argued that there was an overhead cost to labor that employers shifted to society when they treated labor as a variable cost by laying off workers in response to a fall in revenues. This was an analysis of market failure very much in the tradition of A. C. Pigou’s Economics of Welfare. “If all industry were integrated and owned by workers… it would be clear to worker-owners that the real cost of labor could not be materially reduced by unemployment.”

    Clark also acknowledged that employers tended to retain a core of key employees even during slack product demand to avoid costs of delays, re-hiring and training when business picked up. It is this latter subordinate point that Oi emphasized in his analysis of quasi-fixed costs.

    If one ignores the fixed social overhead costs of labor and cost-shifting aspects of Clark’s analysis, then employers’ quasi-fixed costs might seem to be almost a gift of employers to society, instead of an only *partial* internalization of externalities. It’s like if oil companies paid the cost of pipeline spill clean-ups but not for tanker spills or climate change.

    Quoting myself:

    “Following Oi, the notion of fixed costs underwent a remarkable inversion. Instead of referring to the cost of sustaining each worker, regardless of whether employed or not, it has become an employment cost (e.g., “fringe benefits”) that doesn’t vary with hours worked. The aspects of cost shifting and of social cost have been omitted.”

    Click to access walker2011.pdf

    The implications of the omission for productivity are rather far reaching. Productivity, after all, is output divided by hours of work. The next sentence of my paper, cited above, points out one of the consequences: “the existence of these fixed, per employee costs has become a stock rationale for why reducing the hours of work, by “increasing the overtime premium does not appear to be an effective method of decreasing unemployment.”

    Looking for an explanation to the productivity puzzle in quasi-fixed costs is thus like peering intently trees while being oblivious to the forest. K.W. Kapp further developed Clark’s notion of cost-shifting and the social overhead costs of labor as did the late Robert Prasch.


  4. 4 David Glasner July 5, 2016 at 10:32 am

    Miguel, Thanks.

    John, Productivity measures a ration between output and input. If you move a factory from Massachusetts to South Carolina, productivity will increase or decrease according as the ratio of output to input in the South Carolina factory is greater or less than the ratio of output to input in the Massachusetts factory.

    If you move the factory to Taiwan, productivity will increase or decrease according as the ratio of output to input in the Massachusetts factory was less than or greater than the average ratio of output to input for all US factories.

    Tom, Thanks for your comment. Obviously the concept of quasi-fixed factor costs is a rich one, and I was just looking at it from one very narrow angle, but that does not mean that it was not relevant to the specific issue that I was addressing.


  1. 1 Cyclical versus Secular Causes of Stagnation | Uneasy Money Trackback on March 10, 2017 at 10:47 am

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

Follow me on Twitter @david_glasner


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