Everyone wants higher productivity

Since the financial crash and again since Covid-19-related lockdowns there has been evidence of slower labour productivity growth rates both sides of the Atlantic.

| 12 min read

Productivity is the fuel of prosperity. More productivity can deliver workers higher wages, shareholders higher dividends and governments higher tax revenues. It is the Holy Grail of economics. It is the poster child of many political parties but can also prove elusive, often knocked off course by wars, recessions, and bad policy.

Big advances in productivity have underpinned rising living standards and the good performances of shares over the longer term. Since the end of the Second World War, waves of technical innovation have helped fuel more investment, adding to world incomes and capital stock and increasing worldwide wealth.

The 1950s and 1960s were golden days for factory automation. The 1980s and 1990s saw the communications revolution, as mobile phones and computers became more commonly available. Today, people have big hopes for artificial intelligence and the latest developments of the internet.

A slowdown in productivity growth

Since the banking crash and great recession of 2008-10, there has been a slowdown in productivity growth, with further disruptions to economies from the Covid-19 lockdowns. US labour productivity has been growing faster than that in Europe.

US productivity growth slowed to 1.5% a year between 2007 and 2019, down from 2.8% before the market crash. It has recovered to 1.6% since 2019. European Union (EU) labour productivity fell by 2.5% in 2009 and only managed to grow at an average of 0.8% a year from 2010-19. Since then, it has been almost static, with a big fall in 2020 and a recovery in 2021-2. (US Labour Bureau and Eurostat data.)

The US, which records total productivity growth, shows how this has been slower than growth in labour productivity, reflecting the substantial investment in labour saving in the US.

The weaker figures since 2009 have led some to question whether we now have to live with a lower rate of productivity growth. They ask if this means bad news for savers and investors, reducing the returns that can be made. The US record and digital investment have offset some of that worry.

So, what is productivity?

Labour productivity

What is this “productivity” that has declined and how it is measured? People are usually referring to labour productivity, which is measured by dividing the output an economy produces and sells by the number of employees needed to deliver it – or by the hours worked by the workforce. There are no value judgements made about the worthiness of the tasks or the hard work of the labour. It is assessed by the money received for the output compared to numbers or hours worked to achieve the sales.

This means that a small team of investment bankers earning large fees from merger advice are said to be much more productive than a team of nurses offering healthcare because they generate so much more money per person. It means that an employee working in a very automated fossil-fuel plant is said to be more productive than people putting in loft insulation because, again, the output they are associated with – largely made by automated plant – sells for so much more money. Doing unpaid jobs at home does not get included so a lot of work is unrecorded.

This also means that, for any given economy, the main way to increase productivity is to put more capital behind every worker to boost their output – or to switch more people from lower productivity sectors to higher ones.

A construction company that still digs holes and trenches with shovels and picks will be much less productive than a company using diggers. There will be a few trained digger operatives in place of large numbers of labourers. The more processes that can be automated in a factory the more productive each remaining worker becomes. It also means that economies that specialise in very capital-intensive activities will tend to have better labour productivity figures than those that have more labour-intensive activities.

As economies switch labour from more automated industry to more labour-intensive services, so there will be an overall productivity effect. The better industrial figures will boost overall productivity, but the extra service sector activities may detract from the total.

Capital productivity

To deal with these quirks of the numbers, some look at total factor productivity. This is an attempt to see what is happening both to the productive use of labour and of capital. It is only worthwhile spending a lot of money on labour-saving equipment if that improves the overall balance between total costs and revenue from the product.

It is possible to fully automate most processes in a factory and many processes in an administrative office providing services. The more that is automated the higher will be labour productivity. Some may be very expensive and difficult to automate, so automating them will lower capital productivity when large capital sums are committed to the task.

If you measure both the cost of labour and the cost of capital in common money, then you can compare the relative advantage of more mechanisation and can derive a total factor productivity figure for labour and capital combined.

When automating services, the investor must also consider other effects of change. A personalised service relying on individuals to talk to customers may be more attractive and useful to the customers. Changing it to an automated process may lose business as some may not want to travel that journey with the supplier. Putting in a quality variable is difficult to judge in numbers but may be a crucial part of a successful business decision.

Energy productivity

It is possible to consider the productivity or efficiency of the use of other factors of production, including energy and raw materials. If a manufacturer can make a good quality item using less energy than a competitor, they may well have a competitive advantage and a cheaper product from reducing energy use.

There is currently considerable attention on how to eliminate fossil-fuel energy and how to cut total energy needed for many processes and purposes. The same can apply to the use of raw materials, where cutting out waste or finding a better design which minimises the use of expensive materials can boost overall productivity and competitiveness.

Public sector productivity

It is difficult measuring productivity for public-sector work, which is often not charged to customers through prices but paid for from general taxation. Governments must develop indices and figures to capture output, which can then be compared to the number of hours worked or the number of employees. These numbers can show that an increasing public sector detracts from total productivity growth, given the nature of the activities.

Service quality may need more employees not less, as with education, where people often value smaller classes or more one-to-one tuition. Similarly, healthcare may require more employees to look after the sick and elderly well, reducing apparent labour productivity. There is often then a discussion about whether the apparent fall in labour productivity has been worthwhile because there has been a rise in quality.

The impact of recent events and trends

Since the financial crash and again since Covid-19-related lockdowns there has been evidence of slower labour productivity growth rates both sides of the Atlantic. The great wave of investment in digital technology has brought some advances in labour productivity, but recently much more of that investment has been facilitating more working from home rather than more work being achieved.

There are divided opinions on whether working from home lowers or raises productivity. It is likely it does both depending on the motivation of the employees concerned and the ability to do without an office environment for delivery of the service. Well-motivated, hard-working staff can be more productive at home, eliminating the wasteful journey to the office. Clock watching employees have more scope to take time out in the day or to deliver less if working at home.

Most office-based service companies are finding hybrid working is flexible and can provide good outturns for the company and individuals. You might achieve more quiet individual work at home but need to be in the office to collaborate and socialise ideas.

The green revolution promises more jobs in high productivity areas such as the generation of renewable energy.

The green revolution promises more jobs in high productivity areas such as the generation of renewable energy. New cars and heating systems could allow more fuel efficiency. It also requires the premature retirement of jobs scored as highly productive by the accounting conventions in fossil-fuel energy and the manufacture of fossil-fuel-using products. It means early write-off for trillions of dollars of capital based on fossil fuel activities.

These are negatives reducing the productivity of the workforce and of the stock of capital. There are arguments over what the net position will be. The overall change to some economies very dependent on fossil fuels will be negative as they lose those jobs that produce fossil fuel which score highly in the productivity figures unless they replicate their fossil fuel dominance with renewables dominance. Other economies that do not have fossil-fuel resources of their own have more scope to win from transition by replacing imported energy with home produced renewables.

What lies ahead?

It appears from recent trends that the US is better able to grow labour productivity than Europe. The US is leading the world in the fast-growing digital areas and is applying the new technologies faster to its own economy. The Europeans are struggling to recover productivity growth after the twin hits of the banking crash and Covid lockdowns.

For any given country a slowdown in productivity growth results from a mixture of forces. It may be the temporary or permanent loss of turnover from activities that score as highly productive – such as investment banking and oil and gas. It may be a further switch to services from manufacturing. It may be a growing public sector. It may be a general trend as societies age, which sees more demand for people-intensive services affecting the balance of gross domestic product. It may be the general move to more highly regulated activities in many areas, so the ratio of regulatory staff to staff delivering service rises.

The productivity slowdown should not be a surprise, given the limits to automation, the shift to services and capital diversion to replace one way of making energy with another. There is still scope for more productivity gains from capital and technology, as innovators rush to develop commercial uses for artificial intelligence and as software engineers find more labour-saving programmes to help business. The arrival of robotics in more areas will also help.

Investors need to recognise the overall impact of lower productivity growth but can benefit from the continued pressure to do “more with less” and to achieve more through new ideas. This is an era of rapid change from both the digital and green revolutions, which will produce plenty of investment opportunities.

As markets are reflecting, some of the main positive drivers of productivity and more investment revolve to a considerable extent around the digital revolution led by large US companies. Productivity remains central to company and economy performances. In recent years, productivity trends have been better in the US which has been reflected in stock-market performance.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Everyone wants higher productivity

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