Factors that constrain labour productivity growth

Living standards could fall unless more is invested in research and education

DELAWARE: “Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.” (Paul Krugman)

On May 4, 2017, the Bureau of Labour Statistics of the United States Department of Labour released estimates of labour productivity and costs for the first quarter of 2017.

The bureau has reported a decrease in non-farm business sector labour productivity at an annual rate of 0.6% in the first quarter of 2017 compared to the prior quarter.



Furthermore, it records a sluggish increase of 1.1% in productivity from the first quarter of 2016 to the first quarter of 2017. The US has been witnessing a decline in productivity growth for quite some time which has severe implications for long-term growth and prosperity.

Labour productivity is gauged by dividing real output with work-hours of all workers including unpaid family workers. Another way is to measure the Total Factor Productivity (TFP), which shows improvement in the real output beyond contributions of labour and capital.

Simply put, productivity trends show the efficiency of resource allocation and value creation by the labour force and other productive assets of the economy.

The US witnessed enormous growth in productivity from the 1930s to the 1970s. Major contributors to productivity growth were: (a) improvement in the quality of human capital; (b) increase in stock of knowledge; (c) exploitation of spillovers of the World War II; (d) massive investment in research and application of modern machinery and tools in business; (e) development of country-wide infrastructure; and (f) provision of level playing field for aspiring entrepreneurs.

This brought improvements in the standard of living in the US. However, since 1980, the productivity growth has been declining except for a brief period in the 1990s, which was facilitated by widespread application of information technology in business and society.

A recent article in the Wall Street Journal, titled “US productivity fell in the first quarter”, mentioned the weak trend of productivity growth. “The five-year average for the quarterly measure has scuffled near the lowest level since 1982, when the US was mired in a double-dip recession,” it said.

Economist Robert Gordon has eloquently discussed this decline in labour productivity and TFP since the 1980s. He has also projected a pessimistic scenario of productivity growth in coming decades.

Secular stagnation

However, the opposite camp highlights the deficiencies in the measurement of real output and living standards. Many modern technologies have reduced the price of information and luxuries which are not being taken into account at the moment.

Regardless of these opposing arguments, there are considerable signs of secular stagnation in the US economy. As often put forward by economist Lawrence Summers, this situation is more of “secular stagnation” in the US and other developed countries.

Secular stagnation refers to a long-term decline in economic growth which cannot be explained by routine business cycle fluctuations.

The question arises why is there such a decline in productivity? As the dust of the global financial crisis is settling, the dialogue is now moving beyond text book-based fiscal and monetary policy analysis.

In addition to demography-driven constraints, business dynamism is now gaining traction in policy dialogues. New firm formation and business churning - reallocation of resources to more productive and growing firms - have been the key to productivity growth.

The Brooking Institutions and National Bureau of Economic Research have published many studies which report declining business dynamism in the US. Young and small firms are not expanding employment generation and value creation in the way they used to.

President’s Economic Report 2016 reported: “Productivity-enhancing channels may be weakening as the rate of new firm formation has been on persistent decline since the 1970s as have various measures of worker mobility and job turnover. The share of patenting by new firms has also been on the decline.”

Evidence is still inconclusive regarding reasons of slowdown in firm formation and their subsequent growth. However, potential candidates of research point to technology-driven outsourcing and automation, inefficiencies in the patenting process, high cost of regulations, decrease in public sector funding for research, distortions in competition (which favour large firms), shortage of skilled blue-collar workers and rising inequalities.

There are nascent signs of recovery in the US economy. The Economist reported in March “the American economy has added jobs for 77 months in a row”.

There is also speculation about the return of offshore reserves of American companies worth $1 trillion, which may further boost investment. However, it is still too early to conclude whether these developments will improve or worsen the business dynamism which can accordingly influence the productivity growth.

Pakistan’s case

In Pakistan, labour productivity has been slow for many years, estimated at around 1%. Implementation of social and labour standards could bring economic benefits over the medium term through increased motivation and worker productivity.



There have also been calls for labour law reforms in a bid to enhance worker welfare and productivity.

According to International Monetary Fund (IMF) Managing Director Christine Lagarde, living standards around the world could fall unless governments invest more in research and education that can help revive weak productivity growth.

Economists have long viewed productivity gains as essential for sustaining higher wages and living standards, but have struggled to explain a protracted slowdown in productivity growth since the early 2000s.

Lagarde said the post-crisis recession has left a “permanent scar” on output per worker and TFP, a broad measure of innovation that includes both labour and capital inputs.

The writer is a public policy practitioner and researcher

 

Published in The Express Tribune, May 22^nd, 2017.

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