The global phenomenon of slowing productivity

Although Australia has managed a remarkable 26 years of unbroken economic growth, productivity has slowed here, too. Illustrations by Ben Sanders.

It’s a worldwide problem: economic productivity should be rising … but it’s not. Experts can’t agree on whether it’s due to the global financial crisis (GFC), zombie companies or a complex mix of other factors, but they all agree that things haven’t been this bad since the 1950s.

Across the world, the engine of prosperity is spluttering. The amount that is produced for every hour of work is barely increasing (and may be falling in places), putting a brake on living standards in the developed world and slowing the rate of improvement in emerging economies.

The last time productivity growth was so slow among OECD countries was 1950, when the Communist Party had just assumed power in China, North Korea was yet to invade the South, and television was still an exotic wonder for most.

International Monetary Fund (IMF) researchers estimate that total factor productivity (TFP), the crucial X-factor for growth after allowing for hours worked, employment, investment and population growth, is increasing in advanced economies at no more than 0.2 per cent a year.

What has governments and economists particularly alarmed is that this does not appear to be a passing phenomenon.

OECD area productivity growth was already on the slide before the global financial crisis hit in 2008, and has been sharply lower ever since.

Related article: The GFC 10 years on - will rising household debt spark another financial crisis?

In the US, for instance, productivity growth averaged 2.1 per cent a year during the post-war period to 2004, dropped to an average annual 1.2 per cent between 2004 and 2011, and has fallen to just 0.6 per cent a year since.

The UK, meanwhile, has to grapple with its exit from the European Union at a time when the nation’s productivity growth has slumped to just 0.3 per cent. As dire as that seems, it’s an improvement on 2016’s rate of 0.1 per cent, as reported by the Financial Times

Although Australia has managed a remarkable 26 years of unbroken economic growth, productivity has slowed here, too.

While multifactor productivity (another term for TFP) made up more than half of the average annual 3.9 percentage point gain in labour productivity between 1993-1994 and 1998-1999, the Australian Productivity Commission's Five-Year Productivity Review, published in August 2017, said it had made no contribution at all to the annual 1.6 per cent lift between 2003-2004 and 2007-2008, and only around 0.2 per cent to each of the 2.2 per cent gains made each year since.

“The capacity to get more out of all inputs [multifactor productivity] has fallen away since 2002,” the commission said. “The return to average labour productivity outcomes … has almost entirely reflected the contribution of one production factor – more physical capital.”

Productivity: everyone’s underperforming

The striking thing about this slowdown in productivity is that it is not limited only to developed economies. As Bank of England chief economist Andrew Haldane stated in a March 2017 speech at the London School of Economics, “The slowdown of productivity growth has clearly been a global phenomenon.” 

Since 1980, median productivity growth among both advanced and emerging economies is 1.75 percentage points lower than it was in the three preceding decades, Haldane said.

Even countries with fast-growing economies are not immune, and solutions are not obvious or agreed upon. “I do not have a simple explanation, much less an oven-ready solution, for these productivity puzzles,” Haldane added.

In China, India, Indonesia, the Philippines and Malaysia, gains in productivity hover around or below 2 per cent a year.

The consequences for growth and prosperity are stark. IMF researchers said in its 2017 Gone with the Headwinds: Global Productivity report, almost half the drop in advanced country output since the global financial crisis is down to the deceleration in TFP, and “in emerging market economies and low-income countries, slower TFP growth represented an even greater share of output losses.”

In Australia, per capita income growth – effectively what people have in their wallets to spend – has stalled despite historically low unemployment rates, putting a brake on consumption and undermining investment. 

It’s a worldwide phenomenon and, as Haldane stressed, “Tackling the global productivity puzzle is among the most pressing public policy issues today.” 

Why productivity is a tricky thing to measure

The slowdown in TFP is especially perplexing because it has coincided with a period of unrelenting innovation that has included the rise of smartphones, the appearance of cloud computing and the Internet of Things, the development of 3D printing, improved robotics and sensors, advancing gene technologies and material sciences, increasingly sophisticated artificial intelligence, and sophisticated global logistics and production systems.

One contention is that productivity is in fact growing, but not showing up in the statistics.

Productivity, particularly in service industries where outputs are less tangible, can be tricky to measure, and the advent of virtually free internet-based consumer services such as news sites, apps, mobile GPS systems and cloud-based services present particular challenges. 

Researchers at the Federal Reserve Bank of San Francisco estimate that US labour productivity growth in the 10 years to 2014 may have been underestimated by as much as 0.2 percentage points, because of a failure to take proper account of the contribution of computers, better electronic communications, semiconductors, software and intangibles.  

Australian Productivity Commission executive manager Ralph Lattimore says, however, that mismeasurement provides at best only a partial explanation. The ability of statisticians to measure productivity accurately would have had to deteriorate substantially in the last 15 years if it was to account for the productivity slowdown, and Lattimore asserts there is no evidence of that being the case.

Some, like US economist Robert Gordon, argue that the world has entered a period of “secular stagnation”, and the current wave of innovations do not jolt productivity in the way previous waves did.

Waiting for tech to kick in

Many don’t buy this, though, and instead think current technologies will boost productivity, but it will take time. Historically, there has been a lag of 20 to 30 years between the appearance of new technologies and a subsequent lift in productivity, and research on the Internet of Things by the McKinsey Global Institute found that “productivity improvements do not result from information technology alone … Real productivity gains required significant changes in business processes.”

Related to this, OECD research provides a more nuanced glimpse of the productivity slowdown, highlighting stark differences in the productivity of companies within the same industry. In the past, productivity improvements achieved by firms at the leading edge would spread through a sector as companies felt the pressure to remain competitive. Now, however, the gap between the best performers and the rest is widening, suggesting that productivity gains are not being disseminated as effectively as they used to.

Lattimore says productivity among leading manufacturers is growing at 3.5 per cent while the tail of poorer performers is growing ever-longer. The productivity gap in finance is even wider, he says.

As the Productivity Commission baldly observed in its 2017 report, “Something is awry in our economic fundamentals,” although just what is less clear. Lattimore says one possibility is that lagging companies lack the capacity to adopt the productivity-enhancing technologies and practices of competitors at the frontier. To put it another way, such technologies and practices are less transferable than they used to be.

Confronting the zombie companies

The rise of so-called zombie firms may be contributing to the world’s productivity problem. OECD researchers argue that zombie firms (those that would go under without government assistance or support) drag on productivity in two ways: they are typically less productive themselves, and make it harder for new, more innovative and productive entrants to get a foothold in markets.

Given that investment is a prime means by which technology and management know-how is transferred, the misallocation of capital caused by zombie firms and exacerbated by the easy financing conditions that have prevailed since the 2008 global financial crisis (GFC) only serve to deepen the problem. 

The OECD stressed in its 2017 report, Confronting the Zombies, “The inappropriate design of insolvency regimes may stymie productivity growth by delaying the liquidation or restructuring of weak firms.” 

Despite these drags on productivity, the IMF believes the potential for TFP catch-up in emerging economies – the possibility of big leaps in productivity driven by investment in more advanced technologies and business processes – remains strong, and there is evidence in some that the machine of prosperity is regathering some pace.

Some patchy signs of TFP growth

In countries such as India, Indonesia, the Philippines and Sri Lanka TFP growth is trending higher after a GFC-linked dip. Even so, the IMF warns that it is unlikely to return to the rates of growth experienced in the middle of the last decade. This is due to what it terms “structural headwinds”, including the fading effects of the information and communications technology (ICT) revolution, ageing demographics slowing global trade, and the waning effects of earlier market-based reforms.

The big fillip to global productivity from China’s integration into world trade, which by some estimates boosted median TFP in advanced economies by 10 per cent between 1995 and 2007, is abating as the country’s position matures.

Meanwhile, a slowdown in rates of schooling in emerging economies, a reduced appetite for difficult structural reforms and a swing in activity toward lower-productivity service industries are all weighing on emerging economy productivity. 

The IMF’s assertion in its Gone with the Headwinds report that “advancing structural reforms and nurturing open trade and migration policies … have delivered sizeable TFP gains in the past” is also likely to meet its own political headwinds.

Lattimore, like the IMF, thinks the productivity slowdown has multiple causes, and reversing it will be similarly complex. The Bank of England’s Haldane agrees, saying: “If history is any guide, there is unlikely to be any single measure which puts productivity growth back on track.” 

Every sector has its own productivity challenges, and within each sector some businesses perform better than others. However, Lattimore adds that governments can make a big difference through policy priorities and investments that improve education and population health, streamline regulation and lower business costs.

Though many currently baulk at making the investments and tough choices needed to boost productivity, political unrest fuelled by stagnating wages and slowing gains in prosperity is intensifying. They might soon not have a choice. 

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The role of government in lifting productivity

Business is on the front line when it comes to lifting productivity. In trying to increase profits and remain competitive, they often seek to do things differently and better by coming up with their own ideas as well as drawing on the expertise and experience of customers, workers, suppliers and rivals.

This is the fundamental engine of progress in open, market-driven economies. Australia’s Productivity Commission argues, however, that governments play a vital role that should not be overlooked.

“Governments are one of a nation’s leading tools for change,” it said in its August 2017 productivity report. The pervasiveness of governments as employers and regulators, and the support for productivity they provide through investments in health, education and infrastructure, can make them an effective catalyst for change.

It has recommended almost 30 measures national, state and local governments in Australia can take to boost long-term productivity by improving population health, education, infrastructure, reducing red tape and supporting open and competitive markets.

Productivity Commission recommendations:
  • eliminating stamp duty and transitioning to a broad-based land tax 
  • reforming the national energy market
  • making tax reform the centrepiece of a Commonwealth-states joint reform agenda
  • improving governance arrangements for public infrastructure
  • piloting road user charges
  • reserving road-related revenues for road repair and maintenance funds
  • diverting about 3 per cent of public hospital funding to public and preventive health measures
  • bringing taxation of wine in line with other alcoholic beverages
  • withdrawing federal government funding and rebates for low-value medical treatments
  • boosting teacher skills and quality
  • teaching proficiency, not competency
  • establishing independent assessment of skills

Power failure

Infrastructure is often high on government shopping lists when they consider productivity-enhancing investments, but the outcome can be disappointing.

As an example, Australian Productivity Commission executive manager Ralph Lattimore cites the massive investment Australian power companies have made in upgrading electricity transmission grids.

Lattimore says there was a huge overspend that has resulted in “gold-plated” transmission systems that are well in excess of requirements, and have been paid for through a big jump in power prices for consumers rather than any increase in productivity.

The outlook in China

Amid the good news about China’s economic transformation and the rise of mega-cities Shanghai and Shenzhen, it is easy to forget that development in much of China is to varying degrees lagging behind the first-tier cities. Some of China’s  firms are at the global cutting edge in terms of technology, expertise and productivity, but there is a gulf between them and their less developed rivals, says Shanghai-based McKinsey Global Institute director Jonathan Woetzel.

“We see a vast disparity between the performance of the top quartile of firms and the long tail, the bottom 50 per cent,” Woetzel says. 

“While parts of the country appear very similar to advanced economies, a lot does not, and the vast majority of people don’t work at leading-edge enterprises.” 

Various factors have impacted China’s productivity – a shifting investment environment, a vast rural population, the delayed flow-through of technology innovation, and government policy priorities. 

While this gap in productivity (and hence, incomes) is a concern, it is also a situation rich with opportunity. In China, consumption accounts for only about one-third of its GDP, compared with 70 per cent in the US. The scale and importance of consumption will increase as more and more Chinese leave the countryside for the city, and the urban middle class expands.

Woetzel expects competition to serve this burgeoning domestic market, which already numbers 116 million, will act as a huge spur to growth and productivity.

Take logistics. At the moment, getting goods around China is almost three times as costly as it is in the US. Companies able to shrink this cost by investing in advanced systems, technology and expertise, will have a clear edge over rivals.

It is not just competition that is driving Chinese firms to become more productive.

Woetzel says China’s strategy for much of the past few decades has been about investing in infrastructure and urbanisation, to the point that its infrastructure stock, as a share of GDP, is now around the global average.

China’s rate of urbanisation is slowing, the population is ageing, and wages are rising. In this environment China can no longer simply rely on more and more workers to increase production, and instead needs to find ways to make each worker more productive.

For these reasons, Woetzel argues the giant East Asian economy is ripe for a “productivity revolution” in which investment becomes more about quality than quantity, poorly performing firms will increasingly be allowed to fail, and consumers will have greater access to opportunities and services.

Such a productivity-led model of growth could, the McKinsey Global Institute estimates, boost China’s GDP by US$5.6 trillion by 2030, including a US$5.1 trillion lift to household incomes.

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