The productivity problem: causes, consequences and cures

Poor productivity hampers wage growth, stoking public dissatisfaction. As delegates heard at the 2019 Global Government Finance Summit, this is a decades-old problem with complex roots – and one demanding an equally long-term, multi-faceted response. Matt Ross reports

“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.”

Opening the Global Government Finance Summit session on ‘Building productivity, sharpening competitiveness’, Édouard Chrétien was quoting the American economist Paul Krugman. Speaking in Paris to finance department leaders from 10 countries, Chrétien – Head of the Domestic Economic Policy Unit at France’s Directorate General of the Treasury – wanted to highlight one of the biggest challenges facing advanced economies: the chronic fall in productivity growth, which has held down median incomes and stymied economic growth across the advanced economies.

The lingering effects of the 2008 financial crisis have certainly exacerbated the productivity problem: Greg Orencsak, Deputy Minister of Finance in Canada’s provincial Government of Ontario, noted that labour productivity growth across the G7 nations fell from an average of 1.7% in 2001-07 to 0.7% in 2010-17. But this isn’t a new challenge: Chrétien pointed to research showing that productivity growth has been falling in the US, Japan and Europe for decades.

Long-term decline

“It’s been a much longer process than just since the crisis,” agreed Michel Houdebine, Chief Economist at the French finance ministry. “If you look at a very long-term graph, starting in the 1850s, you can see the slowdown in productivity started in the 1970s.” Except for a brief upsurge in the 1990s prompted by major investments in IT, he noted, “it’s slowed down more or less across the board for developed countries.”

That long-term decline reflects the diminishing returns of mechanisation in developed nations; and the ‘third industrial revolution’, built around digital technologies, has yet to generate comparable productivity benefits. The OECD has, said Houdebine, been “trying to look at the impact on productivity of the increased application of digital technologies, and they find figures that are good but that – so far – seem smaller than the productivity impact of previous revolutions.”

It takes time for newly introduced technologies to boost wider economic productivity, he added, and we may find its impact growing as we become more adept at building and deploying digital systems. But we should not, he suggested, bank on digital technologies to rapidly turn around the productivity oil tanker: “There is a world where we see a very big bump in productivity, but I wouldn’t bet on this scenario!”

The roots of poor productivity

Beyond these issues around the nature of tools and technologies, several other factors also hold back productivity. Ageing demographics reduce the proportion of people working in the population, said Orencsak: the number of those aged over 60 has doubled since 1980. And a vicious circle has developed: the Great Recession held down wage growth, encouraging businesses to hire more staff rather than invest in new equipment and R&D. “You have less incentive to invest, because you have a large labour pool available,” commented Miguel Castro Coelho, Chief Economist at Portugal’s Office of the Finance Minister.

What’s more, he said, “there’s some recent evidence suggesting that the effort going into innovation, in the form of patents and all of that, has been increasing for the same level of output: that it’s taking more resources to achieve the same level of innovation.” This further skews businesses’ calculations, favouring the employment of low-wage staff over the uncertainties and risks of capital investment. And when the global economy looks shaky, many companies prefer to build up their war chests than sink money into boosting productivity: “We’ve seen companies hoard a lot of cash, and you do wonder whether that’s the best use of that kind of capital,” commented Orencsak.

Not every business is in the same leaky boat, however. Carlos Martínez Mongay, Deputy Director General in the EU’s Directorate General for Economic and Financial Affairs, noted that while “productivity is going down in almost every sector, within every sector there are companies that are much more productive than others.” This broadening of productivity distribution, he said, “affects almost all sectors and countries: a few companies are highly competitive, whilst the rest are surviving with flat productivity.”

In part, Orencsak suggested, this gap may reflect variations’ in businesses’ ability to make use of new techniques and technologies. “There are underlying structural changes in the economy, and innovation and technological growth may be making it harder for companies to keep up – which might explain some of the divergence,” he said. And Coelho pointed to the important role of good management: one study, he recalled, suggested that if Portuguese businesses were managed as well as their US counterparts, the country’s productivity would rise by 30%.

Unless wages rise, discontent will

Whatever the exact blend of causes, though, the consequences of low productivity growth are clear – and dangerous. Most people’s incomes have barely risen in decades, said Orencsak; but the shift towards digital-led growth, which tends to reward the owners of intellectual property and highly-skilled technical professionals, has continued to drive up earnings for the wealthy. “Income growth has been heavily skewed to upper income earners,” he said: in Canada, the top 0.1% of earners have seen 64% real median income growth since 1982, while population-wide median incomes have risen by just 11%.

This, he argued, is “certainly a source of the mistrust that voters feel towards the institutions of government, and what they see as the representatives of the political mainstream.” And Chrétien quoted 2018 research by Acemoglu and Restrepo, which warns that “if we do not find a way of creating shared prosperity from the productivity gains generated by AI, there is a danger that the political reaction to these new technologies may slow down – or even completely stop – their adoption and development.”

Growing public resentment at the unequal distribution of income growth, added Orencsak, feeds many of the political risks discussed in the Summit’s first session – leading, for example, to “declining support for, if not outright opposition to, the movement of people.” These are, he added, “concerning trends for finance departments.”

So how can government finance chiefs act to boost productivity, with the aim of restoring median income growth and a wider uplift in GDP? Orencsak argued that governments, which have spent much of the last decade trying to cope with the fallout of the financial crisis, must get on the front foot – helping industries and communities to adapt to the changed global economy. “For the most part, fiscal policies in advanced economies have mostly been focused on macro-economic stabilisation, and much less effort in relative terms has been devoted to reforms to foster longer-term inclusive growth, including policies that help the economy adapt to changing demographics, advancing technologies and the impact of ongoing globalisation,” he said.

Act now! Act how?

And there’s plenty that governments can do, said Chrétien – including fiscal tools such as R&D tax credits, and policies to “encourage the mobility of researchers between the public and private sectors.” Training and education is a crucial agenda, he added: countries need “a level of skills in the population that is adapted and fitted to the technologies required” in today’s economy. And Houdebine noted that finance departments have a role to play in ensuring that policies across government support social mobility and more widespread income growth.

Market regulation is another key field for government action. “You can work on adapting the regulatory and legislative framework to the needs of the innovators,” said Chrétien: consulting with business under the France Expérimentation initiative, his country has worked to create a more “dynamic framework, fitted to innovation and encouraging development.” And he pointed to the need to influence the way that resources are allocated between firms, along with measures to facilitate insolvency procedures – helping to ensure that capital is channelled to the most productive, profitable and fast-growing businesses.

Streamlining and lightening regulations can also support business growth, commented Orencsak. “Obviously, regulations have evolved to protect workers, safety etcetera – but over-regulation can present an economic drag, so we have to balance their effectiveness against any unnecessary burdens they create,” he said: governments must find a “delicate balance, calibrating regulation in ways that support growth while retaining their positive effects.” Policymakers can use “regulatory sandboxes” to test out new approaches to regulation, he added, working closely with businesses to create frameworks that focus on outcomes and minimise administrative work.

The task of creating more robust, growing economies, in which the rewards of growth are more evenly shared, is growing ever more urgent. For unless governments’ tax bases are strengthened, central banks and finance departments will remain ill-equipped to deal with future economic downturns – and these are looming ever closer. We’ve seen central banks “ease off on interest rate increases that they were contemplating as late as a few months ago,” said Orencsak. “If economic conditions were to weaken or there was a sudden shock to the economy, central banks have less room to respond than during the last financial crisis.”

And at the root of this task lies the challenge of productivity. “I would be really concerned if we were to treat this as a temporary problem; something to get past,” concluded Orencsak. “We do that at our peril. We’ve seen a very serious economic shock as a consequence of the financial crisis; and part of the roots of what ails productivity can be found in how the economy has changed after the financial crisis. We’ve seen sectors and industries virtually disappear.”

To serve their populations, governments must help people and businesses adapt to this new world – supporting the sectors and industries that will foster renewed, and more equitable, growth.

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