Eco Today - Mar10:ET Master Page 2007 - ASKnLearn

The importance of
productivity growth
P
roductivity growth is arguably
the most important indicator of
living standards in the economy.
Nobel prize-winning economist Paul
Krugman has stated that “Productivity
isn’t everything, but in the long run it is
almost everything.” 1 If the productivity
of resources is increased then an
economy can generate more income or
output per worker, increasing the
standard of living and helping to
eradicate poverty. Higher productivity
growth will increase the economy’s trend
rate of growth. However, because of
the difficulties of calculating the produc -
tivity of certain types of capital, such
as human capital, productivity tends not
to be used as a measure of the standard
of living, so real GDP per capita tends to
be used instead. Nonetheless, there is
no denying the importance of produc -
tivity growth in determining living
standards.
But productivity growth is important
for other reasons. Productivity growth
keeps inflation low. If workers in the
workplace operate more efficiently, then
businesses are able to produce more
goods and services at a lower average
cost, or higher average product (produc-
tivity). If businesses are able to pass
these lower costs on to the consumer
and lower prices, then this will reduce
cost-push inflationary pressure in the
economy. Furthermore, produc tivity
growth drives down unit labour costs,
which will improve the inter national com -
petitiveness of UK goods and services
on world markets.
Measuring productivity
Productivity measures the output
produced by the economy relative to a
given input, or set of inputs. The most
widely-used measure of productivity is
labour productivity, or output per
worker. However, given the fact that over
time there are changes in the structure
of employment, for example between full
and part-time work, or in the number of
hours worked for some other reason,
such as working on Sundays or number
of holidays, then output per hour worked
is actually the more useful measure.
Figure 1 compares productivity in terms
of output per hour worked in the UK with
some other G7 countries. It shows that
the UK performs more favourably on
GDP per hour worked compared to
1. P. Krugman, The Age of Diminished Expectations
(1999), 3rd edition.
Index (Current PPPs)
Figure 1: International comparison of GDP per hour worked, 2007
140
120
100
80
60
40
20
0
Source: ONS
Index (1991 = 100 for all countries)
145
140
135
130
125
120
115
110
105
100
Source: ONS
Japan Germany Canada UK Italy France G7 exc.
=100
UK
Italy
Figure 2: Productivity growth in the G7, 1991-2007
France
Japan
countries that work longer hours, such
as Japan, but less favourably compared
to those who work fewer hours, such as
France.
However as indicated above the
position in one year, 2007, needs to be
seen in a dynamic context – what is the
growth rate of productivity over a longer
period of time? Figure 2 shows that since
1991 UK productivity growth of output
per hour has actually outperformed all of
the other G7 countries. The productivity
of both manufacturing and services in
the UK improved between 1999 and
2008. This is shown in Figure 3 which
also indicates the collapse in produc -
tivity growth during the 2008-09
recession. This is because output
declined during the recession, but the
labour market tends to lag behind the
business cycle. Businesses delay
adjusting their labour force because of
uncertainty over the length of the
downturn.
Canada
Germany
G7 exc.
UK
USA
USA
UK
Figure 2 presents an encouraging
picture of productivity growth in the UK
economy, at least until the 2008-09
recession but we cannot overlook what
Figure 1 clearly shows: a productivity
gap still exists between output in the UK
and that in the rest of the G7 countries.
How do we account for this gap? To do
this we need to look at the evidence of
the UK’s international competitiveness.
International competitiveness involves
two aspects: price competitiveness
and non-price competitiveness.
Price competitiveness is determined by
the economy’s inflation rate, exchange
rate and unit labour costs. Unit labour
costs are calculated by dividing the
average wage rate by the average
product, or productivity. Price competi -
tive ness can be calculated by taking the
real exchange rate, which is the price of
domestic goods relative to the price of
foreign goods multiplied by the nominal
exchange rate.
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