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Economics & Markets

Econosights - Is the world becoming less productive and does it matter?

By Diana Mousina
Economist - Investment Strategy & Dynamic Markets Sydney Australia

Key points

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Global productivity growth has disappointed over the past decade and is running below its long run average.

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This is a problem because productivity growth is a driver of living standards via per capita GDP growth and wages.

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Technology can help productivity, but it is not always the answer. The lack of any significant uplift in productivity growth despite the technological enhancements over the past decade means that: firms are not adopting new technologies, business processes and operations have not changed, the cost of new technology has outweighed any benefits or that benefits are not being fully measured.

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The disruption to global trade from the US/China trade dispute is a negative for productivity growth. Global trade and globalisation encourages investment in new technologies and better business practices.

Introduction

Productivity growth can be difficult to get too excited about. While it is often mentioned by politicians and academics, it is hardly newsworthy. Perhaps this is because productivity is not tangible. It is not easily observed or measurable (like daily changes in share prices) and it is hard to “feel” changes in productivity (unlike feeling the impacts of falling or rising unemployment).

Despite these issues, productivity growth should be given more focus because it is a key driver of long-run living standards. Since the Global Financial Crisis (GFC), productivity growth has increased by an average of only 0.3% annually across advanced economies. Prior to the GFC, it was running closer to 1%. Productivity growth in emerging and developing economies was also hit after the GFC.

But it wasn’t just the GFC that caused a slowdown in productivity growth, it was already slowing before the crisis. In this Econosights we look at recent outcomes in productivity growth, reasons behind the weakness, measures to lift productivity growth and the outlook for productivity.

What is productivity growth and how is it measured?

Productivity is a measure of how well inputs (labour and capital) are being used to create output:

Productivity growth = Total Output ÷ Total Inputs

Therefore, increasing productivity growth can be achieved by lifting output with the same inputs (making your inputs work harder) or cutting inputs and maintaining the same level of output (which is harder to do for businesses).

Measuring productivity growth can be difficult, especially in service-based areas because it is hard to get a measure of output in these industries. Some service areas, like healthcare and education for example, are not output intensive industries (and never will be because of their nature) so productivity is not measured for these sectors.

Because of these issues, productivity growth has typically been measured in the manufacturing industry or production industries where it is easier to compare output and inputs (particularly capital). This is problematic for advanced economies where services industries account for close to 70% of GDP growth.

In this note, we use a measure of GDP per hour worked as our indicator of productivity growth.

Productivity growth in Australia

Australia has not been immune to the global slowdown in productivity growth, although productivity growth is higher in Australia compared to our global peers (see chart below) on average since 2011 (although it has been underperforming more recently), probably a result from being less impacted by the GFC and because of the boost to productivity from booming resource exports over the past few years.

Source: BLS, Eurostat, ABS, AMP Capital
Source: BLS, Eurostat, ABS, AMP Capital

Productivity growth has averaged 1.2%pa since 2011 in Australia (the “post financial crisis period”). Before the GFC, productivity growth averaged at a higher 1.6%pa. The slowdown in productivity growth has been broad-based across industries. The build-up in mining investment in the late 2000’s did hinder productivity growth as labour and capital inputs skyrocketed, without any significant lift in output. After the peak in mining (in 2012) when more mine sites became operational and exports ramped up there was some lift in mining productivity, but it hasn’t really been sustained.

The past year has seen a particularly sizeable decline in productivity growth in Australia. Over the year to June, productivity growth has fallen by 0.2%, after also declining in the prior quarter. One of the reasons for this is because of the concentration of jobs growth recently in traditionally less productive (but not less important) industries like education, government administration and other administration and support services which have had little impact on lifting GDP growth.

Why is productivity growth important?

Productivity growth is a key driver of per capita GDP growth (see chart below), wages growth and therefore living standards.

Source: ABS, AMP Capital
Source: ABS, AMP Capital

Businesses benefit from higher productivity growth via corporate profits, households from higher wages and government budgets from the increased revenue associated with rising corporate profits and household taxation.

Aren’t we in the middle of an IT revolution? Why isn’t it lifting productivity growth?

It is puzzling why productivity growth isn’t stronger despite the significant innovations and improvements in technology over the past decade (better access to data, faster computing speeds and leaps in robotics and machinery). Some commentators believe that it is down to a measurement problem. But poor productivity performance has been occurring for years so it is hard to continually blame the statisticians.

What this recent experience tells us is that new technologies, on their own, are not enough to make significant changes to productivity growth. Firms need to firstly adopt these new technologies and then change their practices, processes and operations using these new technologies which outweighs the cost of these new technologies.

How do we increase productivity growth?

The biggest driver of productivity growth is government policy. In Australia, the Productivity Commission has come out with recommendations on how to lift productivity growth (https://www.pc.gov.au/inquiries/completed/productivity-review/report/productivity-review.pdf for those interested) with various recommendations across industries that aim to improve effectiveness of government institutions and how they operate with the private sector. Important issues for Australia include a review on taxation, energy policy and improving science & mathematics in schools and universities.

Ultimately, it is these government policies that impact the ease with which businesses can operate, support for innovation and level of administration therefore driving business sentiment and investment intentions. Business investment is an important longer-run driver of productivity growth. The chart below shows that business investment tends to lead productivity growth by around a year.

Source: ABS, AMP Capital
Source: ABS, AMP Capital

Infrastructure spending also helps productivity growth in the longer-run. However, it needs to be the appropriate infrastructure that has had the right cost/benefit analysis (in Australia Infrastructure Australia has a “priority list” that ranks the importance of infrastructure projects).

What is the outlook for productivity growth?

Negative hits to global growth in the current cycle post the GFC (like the Eurozone debt crisis, the oil price shock in 2015/16 and the current US/China trade dispute induced slowdown) tend to dampen productivity growth because of the hit to business confidence, investment plans and incomes. Each time there is a mid-cycle shock, the subsequent recovery in productivity growth will be drawn out. The continual hits to global growth since the GFC are one reason why productivity growth has been low.

The current trade dispute will be another hit to productivity growth through the uncertainty created for businesses, the disruption to global supply chains and production and the interruption to investment plans. As well, global trade and globalisation encourages investment in new technologies and better business practices.

Implications for investors

Low productivity growth tends to be disinflationary in the short-term as it is usually accompanied by subdued economic growth. However, in the longer-run it actually tends to be inflationary as unit labour costs rise for businesses. However, there are no signs that low productivity growth over recent years is leading to higher inflation at the moment. This is because economies are still operating with spare capacity which is keeping a lid on inflation. This low inflation, low growth environment means that more global central bank stimulus should be expected, especially to offset the negatives from the trade dispute.

Expect more central bank easing in the US, Eurozone, Japan, China and Australia by the end of the year.

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Diana Mousina, Senior Economist
  • Economics & Markets
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While every care has been taken in the preparation of this article, AMP Capital Investors (UK) Limited, Registered Office at Companies House, 4th Floor Berkeley Square House, Berkeley Square, London W1J 6BX (no. 05524536) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.

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