Magazine article Public Finance

Solving the PRODUCTIVITY PUZZLE

Magazine article Public Finance

Solving the PRODUCTIVITY PUZZLE

Article excerpt

while the worst of the global financial crisis and its aftermath appears to have passed, the risk remains that, as International Monetary Fund managing director Christine Lagarde has noted, 'the world could fall into a medium-term low-growth trap'. Effort needs to shift from coping with the crisis to improving the fundamental drivers of growth. And this, in turn, requires an increased focus on lifting productivity.

In the long run, productivity is probably the single most important factor in determining a country's wealth and wellbeing. Labour productivity shows the output produced from each hour of work. Increasing labour productivity - along with increased hours in work - can lead to more output per person. More output per person - along with higher world prices for what is produced - leads to higher per capita incomes. And higher per capita incomes allow a country to enjoy better living standards, including by providing more resources for public services..

Yet for several years the UK has had weak productivity growth. This preceded the global financial crisis and raises practical questions. At the Bank of England, governor Mark Carney has bet on productivity growth returning. He is gambling on the ability of companies to increase output through productivity gains rather than the more inflationary route of bidding up prices and wages. Lower productivity growth also means Chancellor George Osborne needs to make deeper spending cuts - or increase taxes further - to hit his deficit and public debt targets.

The UK is not the only country with stagnating productivity. Take New Zealand. While these two economies have obvious differences, they are also both experiencing reasonable levels of economic growth, reflecting the rebound from the global financial crisis and, in New Zealand's case, the rebuild after the Christchurch earthquakes. Yet in both countries productivity growth since the beginning of this century has been weak.

Indeed, statistics from the Organisation for Economic Co-operation and Development on labour productivity show that in 2012 the UK needed to lift GDP per hour worked by 19% to reach the average labour productivity for the G7 (see table). New Zealand's labour productivity is even weaker, with its productivity (in terms of the UK's performance) being, in turn, 19% lower.

Like the UK, it has been said that New Zealand presents a productivity puzzle. But its challenges are different In the UK the puzzle reflects a 'jobs-rich recession', where the slump in output has not been matched in the labour market. As the Institute for Fiscal Studies has shown, compared to the start of2008, more people are working but they are producing 2.6% less output on average. The challenge is to explain this decline in productivity, as the standard explanations of firms hoarding labour and changes in the composition of the economy and workforce (such as more part-time workers) cannot adequately explain the fall.

While New Zealand faces different challenges, its experience can throw light on the UK's situation. OECD research recently published by the New Zealand Productivity Commission has shown that the country has good resources - investment in physical capital and average years of schooling are broadly consistent with other countries - and policy settings. It is one of the easiest countries in the world in which to set up a business and its tax and regulation regimes are often seen as world class.

Indeed, the OECD estimates that New Zealand should have GDP per capita 20% above the OECD average. But its productivity performance means it is 20% below. In short, New Zealand poses a real challenge for standard prescriptions for what countries should do to lift their productivity performance.

Internationally, there has been debate on whether the productivity slowdown is a temporary blip or a sign of things to come. In the pessimistic camp, US economist Robert Gordon argues that the slowdown is permanent. …

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