Book Review: The Power of Productivity
Our ancestors were so poor they pretty much ate dirt. Why aren’t we?
My wife’s mother Louise was born in Holland in 1939. She was a young child throughout the Nazi occupation of Holland. The main thing she remembers is there was very little food. They begged farmers for food, got food from soup kitchens, and ate tulip bulbs. In numbers, the Nazi invasion knocked the Netherlands GDP per capita down from $8000 (inflation-adjusted to 2011 dollars) to $4000. After WWII was won, the economy recovered and began to soar.
What’s most shocking about this is the long-term trend. Go back to 1880 and sub-$5000 GDP was the norm in Netherlands and the US. Less money, more starvation, no medicine, much shorter lifespans. Go forward to 2018 and the Netherlands GDP is $48000 — six times what it was in the best days of 1939.
Why are we so much better off than our ancestors, or even our own selves as kids? And, a closely related question (see the trace for Russia), why are some countries better off than others?
The Power of Productivity
The Power of Productivity is one of my favorite books because it does a good job of providing potential answers, and it presents them in detail, so we can easily think critically about them for ourselves. The Power of Productivity argues we are no longer eating dirt because modern rich democracies have a good set of institutions that protect citizen welfare and the integrity and fairness of the markets that provide our food and shelter.
The example failures are the core of the book. Author William Lewis documents countries and industries where failing businesses don’t pay taxes, get electricity for free, or benefit from corrupt laws that treat their competitors unfairly, or have a host of other problems. Most of his examples are from the US, Japan, Korea, Russian, Brazil, India, and Europe. Lewis wrote the book in 2004, but I don’t find it outdated – I’ve never seen any book, newer or older, with this breadth and depth.
Uneven playing fields: Russia Russia Russia – and elsewhere
Russia is the starkest example in the book of a system where markets are uneven playing fields. Some firms pay taxes and energy bills, others do not. Local governments don’t let power companies cut power to small factories who don’t pay their bills. Some firms are favored for government contracts, some are not. Some firms are hassled with red tape, some are not. Open air markets don't pay taxes, foreign retail chains do. This is equivalent to a subsidy for the foreign chains’ competition, so the chains, which are more productive and provide better value to consumers, can’t afford to operate there. And there are similar phenomena in other countries too. For example in Brazil smaller stores don’t pay taxes.
As a result of all this, less productive firms flourish and beat more productive firms. Lewis remarks at one point that the Russian market is literally worse than a centrally planned economy.
Japanese Housing Construction
The book tells three great stories about individual industries in Japan. They are a reminder that the devil is in the details. In Japan (as in the US, by the way) there are some things that work wonderfully and some that work badly. It depends on particular regulations and government and institutional choices.
The first story is about Japanese housing construction, which is not standardized. For example, Japanese builders, who usually use post-and-beam systems for support, use 150 different ones. By contrast, in the US, in 1922 lumber dimensions were standardized by the Department of Commerce working with large lumber purchasers. Later bricks were standardized (from 44 sizes to one), as were other construction elements.
The consequences? Japanese housing construction productivity is 45% of that in the US. The average life of a Japanese house is 26 years (!), vs. 44 years in the US. Standardization enables assessment, which enables bank loans, which empower consumers to purchase better homes. But in Japan, banks won’t lend money for mortgages. Also, fun fact: the government does not even publish prices of home sales. The percentage of US houses sold per year is 17x that in Japan. In Japan if you want a house you build it.
To make matters worse, there are no large-scale housing developments in Japan. This is a good time to step back and point out that large housing developments are the big innovation in housing since 1950. They are ubiquitous in healthy housing markets in the US (cheap cities that are not near the coasts), and in the Netherlands. One reason the US and the Netherlands do better: the same level of government has the responsibility to build infrastructure and the ability to tax housing value to pay for it. In Japan, Germany, France, and Russia, this balance is missing. In addition, in Germany, France, and Russia it is hard to even purchase the land. And Japan is also not the only place where it is hard to get a mortgage. In Brazil, banks don’t give multi-decade mortgages because it’s hard to make them work under hyperinflation.
Japanese Retail Stores
For many years, all Japanese shops had to be less than 1000 sq meters, by law. This is, of course, very bad for citizen welfare. Huge chain retailers pass-on lower prices to consumers because they're efficient. In the US, large chain retailers are about 2x as efficient as smaller general stores. Post-year-2000 Japanese law is more NIMBY-style – local governments approve or disapprove retailers, often based on NIMBY enviro concerns like traffic, and are highly influenced by local retailers. Japanese local governments also don’t have their own tax bases – money comes from central government – so they have no incentive to provide more consumer value through higher-gross retail.
Worse yet, Japanese retailers get guaranteed government loans. Much like college loan forgiveness in the US, this is money spent that’s not going to improve welfare more efficiently, as it would with, say, tax credits for low-income citizens.
Inefficient retailers mean efficient retailers can’t compete, so there are no efficient retailers pushing wholesalers and manufacturers to be better. You may know that Walmart and Amazon are known for pushing sellers to reduce prices, which is very good for our welfare. These manufacturers and wholesalers become more productive, reduce prices, and pass savings and improvements on to consumers. At its best, the benefits to consumers are huge. In 1995-2000, US retail/wholesale annual productivity growth was 7-8% per year. This was due to Walmart and competitors catching up to Walmart. Retailers also know what consumers want, because they see them every day, and large chains are good at pushing that information upstream so the desired and best goods are what is made and wholesaled.
In the Japanese system, none of that is happening.
The Auto Industry in Japan, the US, and Korea
In the 1970s my father Jack would joke that Ford stood for Found On the Road Dead. Indeed, in the 1970s it was common to be stranded on the side of the road with a broken American car (and since there weren’t cell phones or breathable fabrics, this was particularly miserable).
By the 1980s, the news in the US was full of stories of how Japan’s auto industry was whooping our ass. Conventional wisdom blamed the US education system. But that was not incorrect. We know this because by 1986 Japanese automakers began building factories in the US, starting with the NUMMI factory in Fremont, CA, a joint venture with GM. (The NUMMI factory now makes Teslas, and is a mile from the Artifact Puzzles factory.) The Japanese plants in the US achieved 95% of their home productivity with US workers. So the problem was not education. Nor the US regulatory environment in 1986.
It was the Japanese automakers. They were better.
Part of how they got there was a different kind of smart government move, made much earlier. In the 1950s, the Japanese Ministry of International Trade and Industry standardized machine tools, fostering the future success of Toyota and other Japanese auto makers. This is the same sort of move that the US housing production industry made in the 1920s, and it’s an example of why The Power of Productivity looks at things industry by industry.
The bigger story, though, is that Toyota was great. We don’t know why it emerged where it did (instead of at Honda or GM). Probably one of the Toyado family was brilliant. But we do know the Japanese auto makers had to compete with Toyota, and after about 1980, so did US automakers. That made them all better.
Korea, unfortunately, protected its auto market for a long time. While it eventually came to make good cars that sell internationally, Lewis argues that it would have done much better if it had done what the US did: let Japanese automakers manufacture and sell their cars in Korea. This worked quite well for the US: citizens get the cars and the jobs making them, and our auto makers learned from these plants and improved over time.
What Lewis makes of all this
Throughout the book, Lewis develops a framework for thinking about all this. To summarize some of his themes:
Government focused on protecting producers rather than consumers is a problem. Consumer well-being literally is citizen well-being. Protecting individual businesses is protecting special interests that lobby – indeed, Lewis might not use this word, but it’s often outright corrupt. Major problems with protecting businesses or business groups: (1) protecting a few businesses or a single business, even one that creates a lot of jobs, is a very incomplete way to protect the the citizenry (2) special-interest protections distort competition and thus harm consumers.
Lewis extends this idea to the domain of political science: guarding the rights and well-being of the citizens is the underpinning of most or all functioning democracies. As such, consumer welfare is tied to the philosophy of guarding citizen rights, perhaps directly through the mechanism of citizens’ votes.
In a fair market, failed managers and owners do just that — they fail — making way for better outcomes for all.
Conclusion
This is a book full of fun facts, and it’s a straightforward read. It’s also the clearest book I’ve found on the topic of why modern high-function countries are well-off. The only other book I would put even close is Hernando de Soto’s book, The Mystery of Capital. More about that another time.