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30 December 2005 Perspectives on Productivity A recurrent theme of economic commentary
by the government and the Treasury has been that economic growth
in the past decade owed much to improvements in 'labour utilisation'
and that, with unemployment now down to low levels, future growth
must depend more on improvements in 'labour productivity'. To this end the government has
organised working party discussions including businesses and unions
about improving workplace efficiency. The external environment established
by its policy directions has been off-limits in these discussions. Does the mantra about labour productivity
make sense? Only to a point: it focuses on outcomes rather than
causes and thus risks shunting policy thinking down the wrong track. The productivity of labour, capital
and other resources is certainly very important. Over the long run
so-called multi-factor productivity growth is the main source of
improvements in living standards for most countries. Thus Americans
enjoy higher per capita incomes than New Zealanders because American
workers are more productive and New Zealanders' living standards
are higher than those of Indians for the same reason. Budget projections put the estimated
trend growth in labour productivity in New Zealand at 1.5% a year.
This is higher than rates achieved in the decades prior to the 1990s
but well below that needed to return New Zealand to the top half
of the OECD income rankings in any reasonable period of time. Economists typically define labour
productivity as output per worker or per hour worked. The concept
has limitations. First, output per worker in an
economy would be higher if everyone worked 60-hour weeks. Few would
regard this as an improvement in general well-being. Output per
hour worked is more relevant. Second, the output of goods and
services depends on other inputs such as capital, which may be substituted
for labour. If substitution is occurring, observed labour productivity
may be increasing rapidly but when all inputs are taken into account,
multi-factor productivity could be growing more slowly or even going
backwards. It is multi-factor productivity that counts. Third, improving productivity is
not necessarily about working harder or even smarter. Many of the
important gains come from ongoing economic openness and flexibility
- the entry and exit of firms, shifting capital and labour out of
unprofitable activities and into more profitable ones, and so forth. This is why sound institutions
and policies that increase economic freedom are the key to productivity
and growth. The economic reforms of the late
1980s and early 1990s improved both labour utilisation and labour
productivity in New Zealand. But the scope for improvements in both
is far from exhausted. As the Treasury noted in its briefing to the incoming government, there are around half a million people in the working age population who are not in the workforce. These comprise:
Many in these groups could be productively
employed, at least on a part-time basis. Changes to employment and
welfare rules would facilitate higher labour utilisation. If half the number in these groups
could be absorbed into the labour force, it would be expanded by
one eighth and would boost economic growth. The productivity of
these workers would improve over time as they gained skills on the
job - labour productivity and labour utilisation are linked. Productivity is an outcome of a
good environment, not a 'driver'. The way to improve productivity
is not to establish government working parties on work and management
practices. It is to increase economic freedom and make business
operation easier. This includes finding ways of improving incentives
through such means as greater competition (eg in markets such as
accident insurance), lower taxation and lighter regulatory burdens.
Investment needs to be encouraged by reducing the cost of capital
(eg through lower taxes on investors) and the risks (eg insecure
property rights) investors face. Investment gives workers more capital
with which to work. Improvements to infrastructure and to education
and training are also important. Unfortunately, too many of the
government's moves have blunted incentives to be productive. For
example, under the Working for Families package many people face
high effective marginal tax rates if they work to increase their
income, and in some cases they may be worse off. Employment law
changes have made our labour market less rather than more flexible.
Increasing regulation and inadequate infrastructure are making business
operation more difficult. If the government is serious about
increasing productivity, it will have to broaden its thinking about
the sources of productivity gains. It must also realise that its
job is to set the rules of the economic game and to manage its own
affairs well (eg to improve productivity in the government-dominated
health sector), not to reach for economic levers. Roger Kerr is the executive director of the New Zealand Business Roundtable. For more information, contact: Roger Kerr Web: www.nzbr.org.nz |