Governments have embraced ‘spray and pray’ economics, throwing money around—large budget deficits or expansionary monetary policies—to restore growth. But long-term prosperity depends on increasing productivity—GDP per hour worked or output relative to total labour and capital inputs.
Productivity performance is driven by several forces. Capital—new equipment—allows more production. A better educated and skilled workforce and innovation can improve output. Entrepreneurship facilitates expansion or entry and exit from markets. Competition and trade improves resource allocation, enhancing productivity.
In advanced economies, productivity growth is now below 1 percent annually, lower than the 3-4 percent in the post-World War 2 era and the more recent 2-2.5 percent. Emerging market productivity growth remains above developed countries but is declining.
The fall reflects shifts in industrial structure. Productivity gains in manufacturing are easier through mechanisation, automation, mass production, workforce training and better supply chains. But major gains from economies of scale and experience curves are now not repeatable. Henry Ford’s revolutionary assembly line was a ‘one-off’.
Unlike manufacturing, services are personal, local, not globally traded and less amenable to automation. The non-routine, non-repetitive dynamics of healthcare and aged care mean productivity gains are not easy to achieve. Management consultants notwithstanding, shortening the time needed to diagnose a disease or undertake a medical procedure is difficult.
This means costs of manufactures—cars, household goods and electronics—have decreased over time. In contrast, education, healthcare, aged care and childcare costs have risen more than general inflation. This is the Baumol effect, named after the eponymous economist, which argues the cost of labour-intensive services reflects intrinsically lower rates of productivity improvement.
With services now constituting 60-70 percent of GDP, the fall in productivity growth in advanced economies is not unexpected.
Recent innovations may be less significant than earlier ones. Many bio-tech, IT and financial innovations are focused on lifestyle, longevity, consumption and entertainment, with limited direct productivity benefits. Robotics, automation, computerisation and artificial intelligence are not new and have been extensively exploited. New energy technologies, such as fracking and renewables, are not as revolutionary as hydrocarbons or electricity.
The impact of better education and training, especially basic literacy and numeracy, may have peaked. Changed work practices, with increasing fractionalising of tasks, require lower skill levels. It is driven by outsourcing to cheaper locations with less skilled workforces and greater use of contracting. This creates a mismatch between workforce skills and industrial requirements with many workers (up to 30 percent) being overqualified for their jobs, especially in developed economies.
Declining educational standards contribute to the malaise. The evidence points to a reduction in the average reading, writing and numeracy skills. In advanced countries, there is diminished focus on mathematics, science, technology and engineering. Western students target careers as online influencers or TikTok stars, not researchers or astronauts!
Proliferation of universities and colleges contributes to mediocrity. Many have succumbed to commercial pressures. Well-funded institutions staffed by well qualified staff with adequate facilities have given way to a pragmatic market-oriented approach to sell credentials to paying students. Combined with the decreasing income advantage of higher qualifications, the increasing cost of education has placed it beyond the reach of many, or forced graduates to start their working lives with significant debts.
An older workforce affects productivity in areas reliant on physical strength, endurance and agility. The disruption of the pandemic, including working from home that is proving difficult to reverse, may contribute to lower output.
The rise of monopolies and anti-competitive behaviours with a few large firms dominating many industries has reduced competition. In technology, a few major chipmakers, hardware makers, computer operating systems, business software providers as well as one search engine, e-tailer and social network act as ‘control points’ (a term coined by Tim Berners-Lee and Yochai Benkler).
Environmental, workplace safety, and product regulations and expansion of legal liabilities abetted by the rise of class actions have made business activities more expensive. It now costs billions of dollars to get a new drug approved for human use. An unwillingness to admit that no activity is entirely risk-free, and accidents or errors cannot be totally eliminated, affects productivity.
Short tenures and short-term performance incentives encourage managers to focus on quarterly earnings rather than risky, longer term initiatives such as research and development or staff training.
Until recently, low interest rates created zombie companies, impeding the shift of capital to more efficient enterprises. The IMF found as much as a third of the slowdown in productivity gains is from this source. Today, high rates restrict capital investment and the supply of credit to smaller and new businesses. The shift away from free trade and rising economic nationalism now also affects productivity.
Channelling a coach who thought football was not a matter of life or death but something more important, economist Paul Krugman in 1994 argued that in the long run productivity is almost everything. But improving productivity is not a panacea.
Prosperity requires balancing improved productivity against product life, quality, waste, repairability and resource scarcity. High output can create overcapacity and ignores the ability to absorb additional supply. Insofar, as productivity gains come from reduction of employment or wages, it reduces demand. Improving output without addressing issues of employment, income, inequality and conserving precious raw materials ultimately impoverishes societies.
Throwing money about is easy, but does not address any of this and isn’t going to bring back sustainable growth. That requires painstaking and difficult structural changes.
(Views are personal)
Satyajit Das | Former banker and author