The long stagnation in UK productivity might be over. Next week’s figures could show that total hours worked have been flat recently. With GDP growing, this means that productivity has grown since the middle of last year, having stagnated for the previous 10.
Is it really a coincidence that this has happened after a strong rise in share prices in recent years?
No, according to recent research. New York University’s Mark Gertler and colleagues show that movements in share prices over five-year periods are associated with subsequent productivity growth; rising share prices lead to rising productivity, and falling prices to weaker productivity. This corroborates a finding by Christopher Gunn at Canada's Carleton University.
This doesn’t happen merely because higher share prices lead to more capital spending. In fact, this has been weak in the UK for the last few years. Instead, says Professor Gertler, it is because the same things that drive up share prices – such as expectations of future growth and willingness to take risks – also encourage companies to innovate. And such innovations eventually raise productivity.
As Oxford University’s Simon Wren-Lewis has said, companies will only invest in new products, training or new processes if they think that future demand will be high enough to justify incurring the expenses of doing so. And, of course, expectations of higher demand also drive share prices up.
In this sense, expectations can be self-fulfilling.
These productivity-enhancing innovations following stock market rises do not mean that companies replace workers with capital, Quite the opposite. The National Institute of Economic and Social Research (NIESR)’s Roger Farmer has shown that rising share prices also lead to falls in unemployment.
In fact, says Mr Farmer, so strong is this relationship that central banks should try to stabilise share prices – for example, by using quantitative easing not to buy government bonds but to buy equities.
Whether this is a good idea depends on what precisely is the link between share prices and future unemployment and productivity. It might be causal – if rising share prices raise investment by cutting the cost of capital; or if wealth effects raise consumer spending; or if the high animal spirits of equity investors infect* company bosses and so cause them to invest and innovate. Insofar as this is the case, then there is a case for policies to stabilise share prices.
On the other hand, stock markets might reveal causes of downturns rather than be causes of them. If, for example, prices fall because of higher risk aversion or lower demand expectations, then stabilising equities might not do very much to fix the economy because it treats a symptom rather than the underlying ailment.
There is, therefore, a genuine debate. But there is something that macroeconomists increasingly agree upon – that moves in stock markets matter. Not day-to-day ones – which are mostly just noise – but ones that play out over many months. We can no longer dismiss the stock market in the way the Nobel laureate Paul Samuelson did: “It has predicted nine of the last five recessions".
*I say 'infect' because Christopher Carroll at Johns Hopkins University has shown that economic expectations spread across people in much the same way that diseases do.
