Transcript Ruth Tarrant, Head of Economics and Politics, Bedales School.

Why is productivity growth
so vital?
Ruth Tarrant, Head of Economics and Politics, Bedales
School.
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What is productivity
and how is it measured?
• C According to the Office for National Statistics “increasing productivity is
generally considered to be the only sustainable way of improving living
standards in the long term.”
• C Technically, productivity refers to the ratio of outputs to inputs, but
governments are usually most interested in ‘output per worker’.
• C In the UK, productivity is measured by the ONS in two ways.
• C One method is to divide the total output of the economy (i.e. GDP) by the
total number of hours worked, to get ‘output per hour of labour’.
• C The second method is to divide total output by the number of workers
employed.
• C The two numbers can be quite different, as they reflect different working
patterns i.e. the second method gives a lower number when there are
more part-time than full-time workers.
The productivity picture
in the UK 1
• C Figure 1 shows that productivity growth in the UK has been very poor, not
only in the two years shown but as far back as 2007.
• C In 2012, the UK’s output per hour was 16 percentage points below the
average of other industrialised economies.
• C In terms of output per worker, the UK’s performance was even worse, at 19
percentage points below the average of other industrialised countries.
• CThis amounted to the UK having the
widest productivity gap with other
industrialised countries since 1994.
• CThe ONS estimates that the UK’s
productivity is 15 percentage points
lower than it would have been
without recession, and says that the
slow rate of UK economic growth is
due to sluggish productivity growth.
The productivity picture
in the UK 2
• C Many economists in the past year or so have been perplexed by the UK’s
so-called ‘productivity puzzle’, in which more people have been getting
jobs yet output has barely risen.
• C This is in stark contrast to previous UK recessions, in which productivity
picked up again quite quickly after the trough of the slump, causing rising
GDP and a return to greater economic prosperity.
• CThe Figure below illustrates this
point and helps to explain the
current even greater concern over
the impact of poor productivity in the
UK.
The importance of productivity
Growth – the microeconomics
dimension 1
• C Productivity growth should mean, in a competitive labour market, that workers
receive higher wages, and that businesses enjoy falling average costs which can
increase their profitability.
• C Wages are determined at the point where demand for labour is equal to the supply
of labour.
• C The demand for labour is determined by the Marginal Revenue Product (MRP) of
workers, which is the extra revenue generated by employing one more worker.
• C Businesses will only pay a worker a wage that is equal to, or less than, the worker’s
MRP.
• C MRP is calculated by a worker’s Marginal Physical Product (MPP) multiplied by the
price of the products they make.
• C MPP is the extra output made by an additional worker, and is effectively a measure
of their productivity.
• C Therefore, if the productivity of workers rises, their MRP rises, and so their wage
rate rises.
The importance of productivity
Growth – the microeconomics
dimension 2
• C The impact of productivity growth on businesses is also important.
• C Higher output per worker is the same as an increase in productive
efficiency.
• C This should reduce a firm’s average costs (costs per unit).
• CIf the firm is able to continue selling its
products at the same price, then this
cost reduction will lead to an increase
in profits.
The importance of productivity
Growth – the microeconomics
dimension 3
• C Profits are important to businesses for a number of reasons.
• C Profits provide businesses with a source of funds for buying new capital
which means that businesses can invest and grow.
• C This may mean they become more dynamically efficient (producing better
quality or better designed products, or develop a better production
process) and can employ more workers.
• C Also, profits may be given out to shareholders in the form of dividends,
which often leads to rising share prices and a more valuable business.
• C This can make it easier for businesses to raise future funds from
shareholders, providing a more sustainable future source of finance.
The importance of productivity
growth – the macroeconomic
dimension 1
• C Rising productivity can be expected to prompt non-inflationary economic
growth, the ‘holy grail’ of economic policymakers.
• C This is because it can cause a simultaneous increase in both Aggregate
Demand (AD) and Aggregate Supply (AS).
• C Workers may benefit from higher wages, if their productivity, and therefore
MRP, rises.
• C Rising income is likely to cause an increase in consumer spending, the
largest component of AD in the UK.
• C Also rising productivity can lead to higher profits for businesses,
encouraging more investment.
• C This increase in both consumer spending and investment should cause AD
to increase.
• C The size of the increase in AD depends on the size of the multiplier effect
and confidence levels.
The importance of productivity
growth – the macroeconomic
dimension 2
• C Since productivity growth means that more output is being made with the
same number of factors of production, this will increase AS in an economy.
• C The size of the increase depends on whether rising productivity has been
achieved by equipping existing workers with better capital or whether some
workers have been replaced by capital.
• C The macroeconomic impact is an increase in GDP as a result of
simultaneous increases in both AD and AS which allows many of the
government’s macroeconomic objectives to be achieved.
• C If the number of workers in the economy remains constant, higher real
GDP should mean higher GDP per capita and therefore higher living
standards.
• C Higher living standards might also be achieved if workers are able to earn
the same level of income by working fewer hours and therefore enjoy more
leisure time.
The importance of productivity
growth – the macroeconomic
dimension 3
• C Also, the price level remains stable, which reduces inflationary
expectations and is likely to mean that interest rates will remain the same,
promoting confidence.
• C The economy also remains close to full employment, reducing the need for
government spending on benefits and allowing them to reduce the size of
the budget deficit.
• C Furthermore, if the price level remains constant and inflation is low, then the
country’s international competitiveness should improve relative to other
countries.
• C Rising competitiveness should lead to an increase in demand for exports,
reducing the size of the current account deficit and boosting AD.
• C Rising productivity is effectively the same as increased productive
efficiency – getting more out of existing resources should mean that fewer
resources are wasted.
• C This is important in terms of the sustainability of economic growth rather
than just growth itself.
Conclusion 1
• C Increasing productivity is relevant to both employees and companies and
also the nation as a whole in terms of macroeconomic objective.
• C Thus higher productivity is a desirable win-win target.
• C This is where supply-side policies are relevant.
• CThis involves investment in both
human and physical capital and also
measures to make product markets
more competitive.
Conclusion 2
• C Productivity growth really is vital for helping economies to grow sustainably.
• C By raising wages, encouraging investment and boosting output, living
standards should rise.
•C
Achieving productivity growth, however, is not easy and depends on getting
many factors right.
• C Governments should encourage greater competition between firms,
provide incentives and opportunities for workers to get the right skills and
ease the process for businesses to carry out investment.
• C They should also encourage research and development and innovation,
and reduce unnecessary regulations and restrictions on businesses.