On Houseman-Mandel and German Productivity

Matt Yglesias reminds us of an important phenomenon:

But since that time I’ve read Susan Houseman and Michael Mandel’s essay “Not All Productivity Gains Are The Same.” I think you can summarize their point this way. Suppose I have a factory where we make airplanes. We’re not going to be making airplanes from scratch. Instead we make airplanes out of airplane parts. And while it used to be the case that we bought our airplane parts from an American factory, now we get them from a Chinese factory and the American factory has closed down. Because my airplane factory’s inputs have gotten cheaper, my factory now registers as more productive. And if the Chinese airplane parts factory gets more productive over time, then my factory’s productivity increases over time as well. But while these productivity gains are perfectly real—neither the airplanes nor the reduced production costs are an accounting trick—this isn’t really the same situation as the one that would obtain if my factory had actually gotten better at building airplanes.

It’s worth remembering that this phenomenon is not unique to the United States, and that, as I noted in an earlier post, it has much to do with Germany’s manufacturing success over the last decade. Dalia Marin writes:


In the second half of the 1990s Germany shifted its strategy and started to invest heavily in Eastern Europe. Its share of outgoing foreign investment to the region increased to almost 30% in 2004-2006.

This new way of organising production by slicing up the value chain has been more important for Germany’s lower unit labour costs than German workers’ wage restraint. According to estimates, German offshoring to Eastern Europe boosted not only the productivity of its subsidiaries in Eastern Europe by almost threefold compared to local firms, but it also increased the productivity of the parent companies in Germany by more than 20% (Hansen 2010 and Marin 2010).

As a result, relocating production to Eastern Europe made globally competing German firms leaner and more efficient helping them to win market shares in a growingly competitive world market. The efficiency gains from reorganising production were particularly pronounced after 2004 leading to a sharp fall in Germany’s relative unit labour costs from 2004 to 2008.

Productivity gains from offshoring are also the main reasons why Germany and Austria experienced only minor job losses as a result of the opening up of Eastern Europe. By finding this new way of producing, German and Austrian firms were able to cut costs and to take advantage of the pool of skilled workers available there. It seems that the fall of communism and the opening up of Eastern Europe happened just at the right time. It allowed German firms to cut costs at the time when globalisation intensified competition and it allowed Germany to cope with the scarcity of human capital which became particularly pronounced in the 1990s. [Emphasis added]

The fall of communism was, as Marin suggests, a positive exogenous shock that proved a tremendous boon the German economy. A 20% increase in productivity is nothing to sneeze at, and I don’t think that David Leonhardt gave the role of offshoring its due in explaining the virtues of the German model.

Of course, the Houseman-Mandel thesis also tell us that German productivity gains, like U.S. productivity gains, might offer less than meets the eye. 

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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