The problem with productivity

Earlier this month, Bank of Israel Chair Karnit Flug warned that Israel’s economic future was in grave danger due to one singular problem – productivity.

By ELI COOK
July 1, 2015 21:03
4 minute read.
money

money. (photo credit: REUTERS)

 
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Earlier this month, Bank of Israel Chair Karnit Flug warned that Israel’s economic future was in grave danger due to one singular problem – productivity. As Flug noted, labor productivity in Israel was 13 percent lower than the OECD average and a full 40% lower than the United States.

“In order to insure our economic and social future,” Flug declared, “we must look bravely at the current situation and act now in order to assure an increase in labor productivity that will allow a constant rise in the standard of living for all citizens of the state.”

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While Flug’s comments may sound dramatic, they were quite conventional. Economists have been warning about Israel’s low productivity for years. Moreover, for the past century or so, nearly all mainstream economists have preached the gospel of labor productivity, a metric that measures (in money) how much economic output the average laborer produces in an hour. Much like Flug, most economists claim increases in labor productivity will automatically lead to higher standards of living for all.

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This claim is misleading for one simple reason: Labor productivity does not measure how much the average laborer actually earns. Rather, it measures how much they produce. One cannot simply assume that increased productivity will lead to increased wages and a higher standard of living (although it is true that increased productivity may reduce consumer costs).

The causal relation between higher productivity and higher compensation is shaky at best, yet ever since American economist John Bates Clark first invented a law called “marginal productivity” in the late 19th century, most economists have assumed that the free market is inherently just and that wages do reflect, more or less, how much workers actually contribute to the production process.

While economists like to make such assumptions (they call them “models”), the facts say otherwise in recent years. No country makes this point clearer than the United States, the very nation that Flug dreams Israel will one day become. If you look at a chart that contains a graph of labor productivity and average wages in the US since 1945, it makes for a striking visual (I recommend googling it.) From 1945 to 1973, labor productivity increased at the same rate as wages. Workers were reaping the rewards of increased productivity. But in the 1970s, something changed. Since then, wages in America have flat-lined.

On the other hand, workers’ productivity has continued to rise, and inequality along with it. Where did all the increased productivity go? Since 1977, a whopping 60% has gone to just the top 1% of earners. Corporate profits in America, unsurprisingly, are at all-time highs. So is income inequality, as the US is now more economically unequal than South Africa during Apartheid.

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Flug called for Israeli laborers to be more productive. Unfortunately she did not focus on the steps that must be taken to insure that these hardearned productivity gains would in fact end up in the average Israeli’s pockets and not in the bank accounts of Israeli tycoons, Chinese corporations (they’ve been gobbling up Israeli businesses of late) or American banks. Flug should have suggested policies which would promise not only higher productivity but higher wages for most Israelis.

IF WE return to that American graph once more, it becomes evident that labor organizing is an excellent way to insure both growth and equality. The US era of equitable growth between 1945 and 1973 also happened to be the period when American union membership was at its peak. Since the 1970s, however, unions have collapsed in America and wages and productivity diverged sharply. In general, there seems to be a clear inverse relationship in American history between union membership and income inequality (you can google that chart too).

In recent months, there has been a burst of labor organizing in Israel. Thousands of Israelis across the country are pushing to unionize, as they understand that to advance their own wellbeing and reap the full rewards of their labor, they must be empowered in their workplace. If Flug and other economists are serious about raising Israelis’ productivity in order to lift up their lives, they must stand behind these efforts as well. Together, they could create a future Israel that is not only productive, but equal and just.

The author is an historian of American capitalism, currently a Fulbright Postdoctoral Fellow (fulbright.org.il) at Haifa University.

He is working on a book manuscript, under contract with Harvard University Press, titled The Pricing of Progress: Economic Indicators and the Growth of American Capitalism.

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