Pricing Power and Lower Potential GDP: One of the results of the Great Recession has been a severe downward revision in potential GDP across many countries. Laurence Ball just had a Vox post on this..., finding that potential GDP is lower by 8.4% on average across the OECD, and up to 30% lower in places like Greece. This is similar to Fernald’s recent finding that potential GDP is lower in the U.S., the only difference being that Fernald finds the slowdown in potential GDP started before 2007. Potential GDP is growing more slowly than previously because of slower capital accumulation, slowing (or falling) labor force participation, and/or lower growth in total factor productivity (TFP).
One interpretation of slowing TFP growth is that we are actively getting worse at innovating and/or bringing innovations to market. For Fernald, the burst of innovations coming from the IT revolution are running out. In a recent Brookings report, new firms are not starting up as quickly, possibly reducing the rate at which new innovations are brought on board. Ball doesn’t really take a stand on what is happening, but the implication is that the Great Recession did something that is pulling down productivity levels.
The point I want to make here is that declining measures of TFP do not necessarily imply that our ability to innovate or bring innovations to market is declining. Measured aggregate TFP can decline, or grow more slowly, even though firms are just as technically productive as before, and are innovating at the same rate as before. Instead, measured TFP growth may be slowing down because of changes in the market power of firms during the recession. ...