Do we want “productivity growth”?
Posted November 18, 2008on:
CPW has requested that we cover the Standard’s coverage of the National-Act coalition agreement, specifically this section:
National/Act agree to close the ‘income gap’ between Australia and NZ by 2025, requiring ‘3% productivity growth per year’. Which is just economic techno-babble. What ‘income gap’ are they talking about? GDP per capita or wages or what? And how would a faster rate of productivity growth close this gap? Anyone who knows what productivity is (the amount of wealth produced in a unit of work) knows that merely increasing productivity doesn’t necessarily boost GDP or wages. GDP = productivity x work done. So, GDP not only depends on productivity it also depends on how many people are in work. And boosting productivity doesn’t lead automatically to higher wages – wages are determined by supply and demand in the labour market, nothing to do with productivity. In fact, productivity grows faster when employment drops because it’s the low quality workers that lose their jobs first and lower quality capital that sits idle first, but wages don’t go up because there is more slack in the labour market.
After reading it we felt that a non-biased explanation of the “economic techno-babble” was in order.
To start with the discussion does have true points in it – however, it takes examples and paints them as facts. In order to weed through this the first thing we need to do is figure out what productivity is.
If there is an increase in “productivity” we get more outputs for the same inputs – however, this can occur in a number of ways. Now over at the Standard they have painted productivity is only average labour productivity – however, as labour is not the only input to production this does not make sense. There are two other primary types of productivity that we cover in economics:
- The productivity of capital,
- Multifactor productivity (productivity associated with the combination of inputs – say labour and capital),
Now the ideas of “labour productivity” and “capital productivity” only give us a partial view – as we are only looking at a single input. As a result, it is the multi-factor productivity measure that we should be looking at – a measure that has performed incredibly poorly in New Zealand in recent years.
To get an idea of what multi-factor productivity is we can look at growth accounting in wikipedia:
Q = A (L x K y)
This expression states that the production in the economy is some function of labour and capital (in this case a cobb-douglas production function) multiplied by a “solow residual” – this “residual” is equivalent to “productivity” in the most general sense. This is the fella that National and Act want to increase.
Now, since the focus is on multi-factor productivity very little of the Standard’s argument is actually true, namely:
- A fall in labour does not increase multifactor productivity – any increase in “average labour productivity” in this sense is captured by the “production function,
- All other things equal an increase in MFP will increase output – as the cost of making “more” is effectively lower,
- Furthermore, higher multi-factor productivity does lead to higher REAL wages – as the country can now make more stuff with the same inputs. Saying that productivity and wages are unrelated is COMPLETELY wrong – when you analyse the data, real wages are a lot more heavily related to productivity than they are to the level of unemployment (which tells us about the tightness of the labour market)!
Of course I do have a criticism of the plan – do they really think that government can “increase multifactor productivity”? As Chris Worthington says “governments now have very little influence on the economy in the old-fashioned, Keynesian sense” – there are small areas where a change in government organisation may improve efficiency but governments ability to influence something as broad as productivity (outside of through compliance regulation and taxes, which neither party is interested in fiddling with in any substantial sense) does not exist.
National and Act are right that higher levels of productivity growth would directly help us close the income gap with Australia – a gap that DOES exist (although it may not even be an issue). However, saying that “we will increase productivity” is not useful – it is like saying “we will magically make trade-offs disappear”, as saying that productivity is higher is like saying that we can do more with less! National-Act will need to come out with clear policies about how they will “increase productivity” – then we can discuss those policies. For now it is only empty rhetoric.
Even so, the Standard’s critique of the truism provided by the National-Act agreement was simply wrong, and as a result deserved to be covered here.