Global Agenda: How to produce productivity

Productivity is probably the most important concept in economics - and certainly the most elusive.

January 11, 2007 22:00
3 minute read.
Global Agenda: How to produce productivity

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Productivity is probably the most important concept in economics - and certainly the most elusive. It means generating more output from a given quantity of inputs of economic factors, such as labor and capital. That's why it's very different from "growth:" if you employ more people, or install more machines, you expect to generate more output. You will have growth, as captured in GDP statistics, but you won't necessarily have improved productivity. Yet, rising productivity is critical because, as Prof. Michael Porter, the acknowledged "competitiveness guru" from Harvard puts it, "productivity is the prime determinant in the long run of a nation's standard of living." Indeed, Porter goes on to say that "high productivity not only supports high levels of income, but also allows citizens the option of choosing more leisure instead of longer working hours" and enables firms to spend more on things such as health, safety and the environment, thereby raising standards of living (in the sense of quality of life rather than merely having more money and material goods). The US is regarded as the paradigm of productivity and other nations seek to approach or exceed US levels. The American economy has undergone a productivity revolution over the last 10-20 years, usually attributed to its success in absorbing new technology and applying it across the economy, not just in hi-tech sectors. Alan Greenspan, the former Fed governor, became convinced that this revolution has had a permanent impact on the economy and came to base his thinking, and hence his policy, on that belief. Others remain skeptical, but all agree that US productivity levels have achieved a much faster rate of growth in the nineties and naughties than they displayed in the preceding decades. Few other developed countries can boast of similar achievements. Even in Australia, arguably the most successful of the developed economies over the last 15 years, the productivity revolution of the 1990s has petered out since 2000. Saul Eslake, chief economist of Australia's ANZ Bank group, presented a fascinating analysis of why and how that happened in a recent article published in the Sydney Morning Herald ( His key conclusion is that the structural economic reforms and deregulation pursued by Australian governments in the 1990s triggered the big improvement in productivity, while the loss of reforming impetus in recent years and the complacent attitude of government and business in the face of a commodity-driven economic boom, has ended the move forward and sent Australia back down the comparative rankings of "standard of living." This conclusion is entirely consistent with the Israeli experience. Productivity in the business sector the only part of the economy in which output can be measured in a fairly meaningful manner" surged in the first half of the 1990s, not because of the influx of olim from the Former Soviet Union, but because of the trade liberalization policy launched in 1990, which opened the economy to imports from the Far East. It faded after 1994, in tandem with the demise of reform in the Israeli economy, and poor economic performance in the late 1990s followed by the recession of 2001-2002 pushed productivity growth into negative territory from 1996 through 2002, except for 2000. However, since 2003, productivity has surged again. This is most clearly seen in the steady decline of unit labor costs (ULCs) - defined as the cost of producing output, and measured by deflating output by the cost of labor. Since output has surged while labor costs have risen at a much more modest pace, ULCs have declined - by almost 9% between the end of 2002 and mid-2006. This represents a massive improvement in Israeli competitiveness and goes far to explain the strength of the bourse and the shekel, as well as the other features of economic strength that have been so prominent. This is more impressive when you consider that Israel has been a victim of the commodity boom, rather than a beneficiary, as Australia has been. But, as Eslake notes, that's just the point: the productivity gains come when countries are pushed to make reforms and they tend to fade when the pressure to reform is removed. That's the danger facing us now - that the combination of economic success, record corporate profits plus weak government ends the surge of reform and deregulation. Only a continued commitment to reform will keep the Israeli success story running, and this commitment has to be actively demonstrated by both government and businesses.

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