ECONOMICS by Colin TeeseNews Weekly
Productivity: do we understand it at all?
, May 23, 2015
Productivity is widely discussed in the media, though rarely to useful purpose. The nature of these discussions – even among those in the business media – mostly reveals a widespread misunderstanding of the subject.
The same is true for the business community itself. Business spokes-people never make clear (either because they don’t understand or prefer not to understand) the differences between productivity within a company, within an industry or within a country.
When business talks, usually it attributes low productivity to excessively high wages. ‘Our businesses can’t be internationally competitive because of high wages and generous working conditions.’
Even if these propositions were true (which frequently they are not) the talk about wages is misguided. Wages in low-wage countries will be reflected in lower prices to consumers. Likewise, pay rates in high-wage countries reflect what wage earners in those countries have to pay for their needs.
In any event, high wages cannot explain why we are uncompetitive against Germany. German business manages to pay higher wages, give generous working conditions and, at the same time, achieve higher productivity levels than similar Australian businesses.
If labour and wages are not genuinely the problem, does this mean that perhaps our businesses are not as well run as those of their international competitors?
Let us now see whether we are able to take further our understanding of what productivity really means and how it can and does impact on economic growth.
There have been few truly analytical approaches to which we can turn for enlightenment. One, however, has been helpful, in that it has attempted a reconciliation of productivity differences between two identical economies: Britain and France. The difference in productivity between those two countries is almost 25 per cent in favour of France.
Ann Pettifor, who is notable for having written a book entitled The Coming First World Debt Crisis two years before the global financial crisis (GFC) hit, heads up a research organisation called Prime Economics. She has commissioned an article on productivity by Jeremy Smith.
While the article has a northern-hemisphere bias, it manages to expose a few useful fundamental truths.
Smith’s controversial conclusions diverge markedly from those found in mainstream analysis.
But before proceeding to any of that let us first take in what Smith has to tell us about his comparison of Britain with France. The first point he makes is that in terms of demographics and economics they are remarkably similar.
In 2013 France had a population, including the overseas territories, of about 65 million: Britain, by comparison had around 64 million. After adjusting for the French overseas territories, the population of the two countries is almost the same.
In terms of national output (GDP) and converted for comparison into U.S. dollars, France in 2012 was $US2372 billion and Britain was $US2368 billion. Two years later the comparable figures were France US$2526 billion and Britain US$2552 billion. Again, remarkably similar.
Nominal GDP per person in France in 1997 was $US22,500; in Britain $US23,500. Comparable figures in 2012 were France $US35,000 and Britain US$36,000. So far as manufacturing industry was concerned the two countries were about the same – 10 to 12 per cent of the total economy was devoted to manufacturing.
Services accounted for about 79 per cent of economic activity in both France and Britain.
Both Britain and France have large deficits on their trading accounts. In fact the sum of British and French deficits amounts to about the same as the German surplus. Between 2009 and 2015 net stock of capital was rising by about 8 per cent a year.
However, when it comes to productivity, the two countries diverge widely, as measured by output per hour worked. The figures favour France by about 25 per cent. In this context it is noteworthy that the two countries, at least since the 1980s have pursued widely differing labour policies.
The record shows that, since the GFC of 2008-09, British productivity, as measured by output per hour worked, has stalled. In media and academic circles this is widely judged to be a danger to future growth and prosperity.
At the time of the GFC output per hour worked fell markedly. It then began rising in 2011 but has stagnated since. Even so, numbers in work, either as employees or self-employed, have increased.
That the British are alarmed about this is putting it mildly; orthodox wisdom has always maintained that from the time of the Industrial Revolution, better use of plant, equipment and labour has been the key to British economic advancement. Falling behind in the productivity race really means something.
Britain is not only falling behind France, but also the rest of the European G7 countries except for Norway (Germany, France, Britain Spain, Italy.) Until 2007 the gap between Britain and the rest of the G7 was 6 per cent; it is now 16 per cent. What might account for this fall, and what it might mean for Britain’s future is still being debated.
The data provided by Jeremy Smith makes it clear how little we know about productivity and what impact it has on economic health and prosperity.
Indeed, Smith’s data relating to the wider defined G7 (U.S., Germany, France, Britain, Japan, Italy and Spain) is quite revealing, in a troubling kind of way.
Putting aside the matter of Japan – for the moment its economy is moving in quite strange ways – the data shows that the U.S. and Spain are at the top of the productivity table. Yet each has enormous unemployment and, in the case of Spain, falling total output.
The U.S. has achieved huge gains in productivity, yet real wages have not improved in more than 30 years. And in recent decades it has run up huge current account deficits as a result of cheap Chinese imports displacing much domestic production. Presumably, the domestic production replaced was “low productivity”. More generally, the divergences within this group of countries are no less difficult to explain than those exposed by Smith for Britain and France.
Then there is the case of Norway, which is part of the earlier mentioned Group of 7 European countries. Norway has the lowest productivity of what might be called the developed West, yet it maintains full employment and the highest standard of living.
What sense can be made of any of this? What may we conclude from it?
In the case of Spain and the U.S. it seems that those in work are active in highly productive industries, but that their productive efforts do not translate into better living standards or employment opportunities across their respective wider communities.
As to the U.S. we must assume that the big productivity gains there have been narrowly distributed, given that real wages, in a highly productive economy, have remained stagnant for 30 years. We know for certain the productivity gains have not generated widespread economic prosperity.
By comparison, Norway, apparently without the benefit of high productivity, has fared much better. However, its particular circumstances need to be recognised. In fact, those special circumstances may throw extra light on the subject of productivity.
Norway’s economic health and prosperity rests heavily on its oil reserves, which, as we all know, must be finite. Oil extraction is, however, a high-productivity industry in terms of output per hour worked. How then, can this be reconcilable with Norway’s low position on the productivity table? And does any of this help explain Norway’s full employment and high standard of living?
Oil extraction and distribution is a government monopoly in Norway. Oil earnings are carefully managed by the government. The amount of oil revenue fed into the economy is carefully controlled to prevent inflation undermining the value of the asset and disturbing the Norwegian economy. (Surpluses over necessary spending are fed into Norway’s sovereign wealth fund, reportedly the world’s wealthiest).
If, overall, the output per hour of Norwegian workers outside the oil industry is low, it could be because some kind of government wage equalisation policy results in higher wages being paid to Norwegian workers in less productive areas of employment. Certainly that would drag down recorded productivity figures for the whole country.
Conclusions drawn from the raw data will, of necessity, be conjectural; and perhaps associated with strongly held ideological positions. Notwithstanding, much can be asserted with some certainty.
First, the most workable definition of productivity should be in terms of output per hour worked.
Second, we can say with some certainty that economic prosperity and productivity gains are inseparable; but there remains dispute about the precise nature of the connection: whether economic gains drive productivity or the other way round.
Third, all the evidence confirms that high productivity, measured by output per hour worked, cannot help us ensure that all the available resources of the economy are fully utilised. Only demand creation at a level needed to occupy to the full all the productive resources of an economy can achieve this.
Fourth, policies relating to the deregulation or otherwise of labour markets are closely connected with productivity outcomes.
Fifth, the distribution of the gains to productivity to the wider community differs widely as between countries, and would seem to depend heavily on government policy prescriptions or the absence of them.
Bearing in mind what important insights have emerged from Jeremy Smith’s analysis of productivity issues relating to many of the major northern-hemisphere economies, is it not time for us in Australia to undertake a truly objective study of what productivity really means and how it impacts on our economy?
Colin Teese is a former deputy secretary of the Department of Trade.