Elusive Productivity

September 13, 2017

Pakistani businesses are doing a terrible job at making their workers more productive. Productivity growth has been the weakest it has been since the early 1980s – only about 0.8 percent a year over the last decade, compared with 2.3 percent on average from 1947 to 2007. This perhaps is also the root cause of slow growth in both gross domestic product and worker pay. At least, this is the standard way of thinking about productivity and its relationship to the economy. In a mainstream view, productivity is a kind of magic force that helps explain rising output. New laborsaving inventions come along or new management practices are taken up that miraculously allows companies to produce more output with fewer hours of work. However, in this viewpoint, one can’t really predict when and how such innovations will arrive. For example, in the USA, when Henry Ford started using a moving assembly line or when Sam Watson perfected the just-in-time supply chain or when easy-to-use word processors became affordable resulting in fewer business people needing secretaries, Voila, the productive capacity of the nation rose, along with incomes and living standards. Closer to home, in Pakistan, this was last seen in the 80s when domestic textile operations introduced revolutionary man to machine ratios never seen before in the history of the textile industry, and as a result Pakistan jumped to being the third/fourth largest producer from being a lowly 21st before that.

But what if this is the wrong way of thinking? What if productivity growth is not so much an external force that proceeds in random fits and starts, but is deeply intertwined with the overall state of the economy and labor market? It is chicken or egg problem: does low productivity cause slow growth or does slow growth cause low productivity ? The second possibility is a provocative argument of a paper recently published by the Roosevelt Institute, a liberal think tank. The paper argues that United States (US) economy is not actually closing in on its full economic potential and has plenty of room for continued growth – so long as the Federal Reserve does not put the brakes on the expansion prematurely. J.W. Mason, the author of the report, argues that soft productivity growth reflects not some unlucky dearth of new innovations, but rather is a consequence of depressed demand for goods and services and a slack labor market that has depressed wages.

May be if the labor market were tighter and wages were rising faster, it would induce companies to invest more heavily in new-labor-saving innovations. What is particularly interesting is that this diagnosis – though decidedly not the policy prescriptions yet in the developed economies – has some overlap with the arguments of influential conservative economists. Again, a recent paper published by the Hoover Institution and American Enterprise Institute (AEI) argued that the production drought in the US was caused by insufficient investment in capital equipment, software, and was poised to rebound in the shape that we see today. It argues, wages raised artificially without any real correlation to market forces – supply and demand of labor – will not only be counterproductive but in reality will hinder investment as companies will go out of business to foreign competitors before being able to meet productivity related investments. So what in essence this paper (3 out of 4 authors of this paper are by the way considered as potential future nominees to lead the Federal Reserve) is saying is that in principle, “Wages should not be fixed arbitrarily by governments and that investment not anything else should be the most powerful force in efforts by companies for driving up their productivity . And such investment, ironically has been the weakest in the US corporations over the last decade.” Companies, according to the authors, are spending their capital budgets not on things that might cause a leap in their workers’ productivity , but on smaller projects to replace old machinery and software and make marginal efficiency gains. In the context of minimum wage debate, pretty much everyone (USA, European Union economies, Brazil South Africa and now even India through its latest labor reforms) in the developed economies is unanimous that the argument about ‘capital substitution’ in response to the increase in minimum wage does not hold true. Despite many studies on this relationship in recent years - interestingly also including one from Fudon University, China – none finds any hard evidence that capital substitution would indeed take place as an aftermath of a minimum-wage increase.

Now ditto this to the situation in Pakistan and what one sees is that we are also suffering from the very malaise on productivity that the AEI paper has been arguing against. Despite excessive labor supply in the market, respective governments have been artificially jacking up minimum wage rates in routine ever year and that too to levels, which carry little business justification. Put simplistically, with the underlying advantage of cheap labor getting compromised, naturally competitiveness took a hit and the result is what we see today: eroding exports and domestic manufacturing closures. To make matters worse ‘Darnomics’ over the last 4 years played havoc. By unnecessarily burdening the rather tiny base of taxpayers it drained profitability from legitimate manufacturing operations, in-turn restraining the real potential for in-house investment that could have led to a meaningful growth in productivity . History tells us that the strongest productivity growth in Pakistan came in the 60s and then the 80s. In both periods advertently or in-advertently the governments of the day focused on investment to carry the day for them economically; and it worked. Every time, we have resorted to cheap but (sometimes) popular political slogans instead of sound economic rationale to make policy decisions, both productivity and (as a result) the country have suffered.