The Modern Firm in Theory and Practice Nick Bloom (Stanford Economics and GSB) Lecture 1: Productivity, firms and plants 1

Nick Bloom, Econ 149, 2015 Start with class introductions 2

Nick Bloom, Econ 149, 2015 COURSE OUTLINE Can good management can make the world a better place? –Raising profits, productivity & employee wellbeing How can we measure management? Use research and case studies to learn about this

Nick Bloom, Econ 149, 2015 Class Question What are the pros & cons of case-studies for management teaching and research? 4

Nick Bloom, Econ 149, Management raises productivity (among other things) Why care about management?

Nick Bloom, Econ 149, 2015 The basics of productivity Changes in firm productivity Changes in aggregate (macro) productivity

Nick Bloom, Econ 149, 2015 Productivity Gross Domestic Production (GDP) per capita – basically Income per person – is a key indicator of economic wellbeing GDP per capita increases by growth of inputs (e.g. more capital or labor) or higher Total Factor Productivity (TFP) 7 GDP = Inputs + Total Factor Productivity (TFP) e.g. Labor, capital

Nick Bloom, Econ 149, 2015 Class Question 8 How do you define productivity?

Nick Bloom, Econ 149, 2015 Measuring productivity (ω i,t ) Labor Productivity: Three factor TFP: Five factor TFP: Note: va=log(value added), l=log(labor force), k=log(tangible capital), m=log(materials, e=log(energy), c=log(IT). If IT included need to remove from tangible capital.

Nick Bloom, Econ 149, 2015 Defining macro (or industry) productivity Define a simple macro productivity index: P t Where: ω i,t is the productivity of establishment i in period t (i.e. log(labor productivity) or log (TFP)) s i,t is the share of establishment i in the country in period t (i.e. the share of employment or sales in the country employment or sales)

Nick Bloom, Econ 149, 2015 Productivity “Facts” Macro: Productivity varies a lot across countries & time –Robert Solow: TFP growth at least as important as growth of inputs in explaining economic growth –Cross country GDP/capita differences largely due to TFP differences Micro: Productivity varies hugely across firms 11

Nick Bloom, Econ 149, Large Income & TFP Differences between countries Source: Jones and Romer (2009). US=1

Nick Bloom, Econ 149, In long-run most countries have enjoyed catch up Growth with the GDP/head leader (US) but not all Source: Maddison (2008) Data is smoothed by decade

Nick Bloom, Econ 149, 2015 Productivity “Facts” Macro: Productivity varies a lot across countries & time –Robert Solow: TFP growth at least as important as growth of inputs in explaining economic growth –Cross country GDP/capita differences largely due to TFP differences Micro: Productivity varies hugely across firms 14 Macro: Productivity varies a lot across countries & time –Robert Solow: TFP growth at least as important as growth of inputs in explaining economic growth –Cross country GDP/capita differences largely due to TFP differences Micro: Productivity varies hugely across firms

Nick Bloom, Econ 149, 2015 Productivity Differences across firms within countries are huge US Census data on population of plants –Plant at 90 th percentile has labor productivity 4x plant at the 10 th percentile, TFP 2x (Syverson, 2011) Not just mismeasured prices: we see these differences in detailed industries where we measure plant prices (e.g. boxes, bread, block ice, concrete, carbon black etc.) 15

Nick Bloom, Econ 149, For example, US ready mix concrete plants: Source: Syverson (2004) High competition Low competition

Nick Bloom, Econ 149, 2015 Distribution of plant TFP differences even larger in other countries – e.g. India Source: Hsieh and Klenow (2008); mean=1 Why might productivity be more dispersed in developing countries?

Nick Bloom, Econ 149, 2015 Class Question Why do we care about productivity? 18

Nick Bloom, Econ 149, 2015 Why we might care about productivity Increasing TFP means that the economic “pie” is bigger so more room for –Consumption increases –Tax cuts –Increases in public goods (e.g. Environmental quality) Harder to achieve if productivity stagnant 19

Nick Bloom, Econ 149, 2015 The basics of productivity Changes in firm productivity Changes in aggregate (macro) productivity

Nick Bloom, Econ 149, 2015 Class Question 21 What causes differences in firm productivity? What is the evidence for these?

Nick Bloom, Econ 149, 2015 Some proximate factors: –“Hard” technology (e.g. Research & Development) –Skills (e.g. Expansion of college education) –Management (a technology & a skill?) Some deeper factors “driving” the above –Competition –Globalization –Regulations & government policies –Legal –Culture 22 Increasing Firm Total Factor Productivity

Nick Bloom, Econ 149, 2015 The basics of productivity Changes in firm productivity Changes in aggregate (macro) productivity Management

Nick Bloom, Econ 149, 2015 Increasing Aggregate Total Factor Productivity Within Firms (from prior slide) –The same firms become more productive (e.g. new technology spreads quickly to all firms, like Internet) Between Firms (“Schumpeterian” view) –Low TFP firms exit and resources are reallocated to high TFP firms > creative destruction 24

Nick Bloom, Econ 149, 2015 An aside on Schumpeter – here he is

Nick Bloom, Econ 149, 2015 Famous quotes from Schumpeter Although probably his most famous quote was: “Early in life I had three ambitions. I wanted to be the greatest economist in the world, the greatest horseman in Austria, and the best lover in Vienna. Well, I never became the greatest horseman in Austria“ To which the (un-attributed) response was: “Those we knew Schumpeter as an Economist, Lover or a Horseman presumed his skills were in the other two fields” “The fundamental impulse that keeps the capital engine in motion comes from the new consumers’ goods, the new methods of production and transportation, the new markets... [The process] incessantly revolutionizes from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact of capitalism.” Schumpeter (p. 83, 1942)

Nick Bloom, Econ 149, 2015 Creative destruction is important, and is driven by massive ongoing churn in the economy About 20% of jobs are created and destroyed in the private sector every year. About 80% of this turnover occurs within the same SIC-4 digit industry This is robust across countries (US, Europe, Asia and SA) A linked (but distinct concept) is turnover in “employment” which is about 40% a year

Nick Bloom, Econ 149, 2015 Turnover in “Jobs” versus “Employment” example Note: Employment flow=14, Job flow=4

Nick Bloom, Econ 149, 2015 Back to increasing aggregate TFP - the within and between channels are well known to cricket fans Within batsman (each batsman improves) Between batsman (more time for your best batsman, to raise your “batting average”) 29

Nick Bloom, Econ 149, 2015 Particularly Important Class Question (David, double grade this one thanks) Which country is the best in the world at Cricket? 30

Nick Bloom, Econ 149, 2015 Formally decomposing productivity into within and between effects (1/2) Productivity growth for a balanced panel of establishments can be broken down into three terms: Within term is included in representative agent models, while the between and cross terms would not be Reallocation

Nick Bloom, Econ 149, 2015 Allowing for entry and exit requires two more terms: This is the Bailey, Hulten and Campbell (1992) decomposition Formally decomposing productivity into within and between effects (2/2)

Nick Bloom, Econ 149, 2015 * Source: John Haltiwanger Total reallocation (between, entry and exit) accounts for about ½ of manufacturing TFP growth *Combines “between” and 0.34 “cross”

Nick Bloom, Econ 149, 2015 (A) Treats all reallocation within establishments as “within” growth Large establishments in balanced panel (500 employees) (B) Reallocation terms most likely to be downward biased by miss measured prices (Foster, Haltiwanger and Syversson, 2008) So in manufacturing re-allocation of factors probably accounts for the majority of productivity growth Following trade liberalizations about half of productivity gains due to shrinking/exit of less productive plants (e.g. Pavcnik, 2002) Caveat: Reallocation is not immediate (e.g. trade dislocation). So many oppose trade as these are losers as well as winners This is probably even an underestimate

Nick Bloom, Econ 149, 2015 Source: Foster, Haltiwanger & Krizan (2000 and 2006) Reallocation (including entry) accounts for almost all Retail TFP growth

Nick Bloom, Econ 149, 2015 The basics of productivity Changes in firm productivity Changes in aggregate (macro) productivity Management

Nick Bloom, Econ 149, 2015 What about management? Case studies of management: –Toyota and British Leyland –Goldman Sachs and Lehman Brothers Obviously management matters but –how to generalize? –how much does it matter? –what causes the differences? 37

Nick Bloom, Econ 149, 2015 Class Question What are the areas of management, do any have best practices? 38

Nick Bloom, Econ 149, 2015 Class Question How would you test if these best practices exit? Would you be happy with case studies (books)? 39

Nick Bloom, Econ 149, Productivity is a key driver of economic welfare – more output for consumption, education, health etc from the same inputs 2.Across firms and countries we see massive variations in productivity (4x differences in both cases is common) 3.Productivity can be raised within each firm through a variety of channels (skills, R&D, better management etc) 4.Productivity can be raised in countries also by creative destruction (productive firms grow, unproductive firms shrink). 5.The US has a lot of creative destruction, but developing countries often do not, so have even higher TFP spreads (and lower growth) Class Wrap-Up