The Cruelty of Productivity

Productivity is the most essential measure of the trajectory of wealth. It measures how much time and effort we put into making or doing things. As productivity rises, we spend less time and effort on those activities, which allows us to divert that time or effort into leisure, thus raising our quality of life, or into making or doing other things, which raises our standard of living in a material sense.

It is the near exponential rise in productivity since the Industrial Revolution that has lifted us out of the agrarian state our ancestors lived in for countless generations.

It is also a very cruel irony at times.

Take the US economy over the last few quarters. Productivity has jumped sharply. That augurs well for future wealth accumulation. But the reason it jumped was that businesses cut their workforces extremely sharply. Hours worked in the economy dropped by about 5.1% in 2009, but productivity rose by 2.5%. Combine these two figures and we arrive at the drop in GDP of around 2.5%. The drop in hours was largely caused by the increase in unemployment during the year – the jobless rate was 3.6% higher at year end than at its start.

So the American economy adjusted to the sudden drop in demand by carving back employment, but some of this loss was offset by the jump in productivity. The overall loss in GDP was thus mitigated.

The implication is that business more than protected itself against lost sales, and over-compensated for the decline by eliminating more jobs than necessary. Having done so, business is now benefitting from higher cash flow and growing profit even while the economy languishes in a very slow pattern of growth.

The enormous slack in the economy created by all the slashing and burning of business eliminates the bargaining power of workers, so the immediate benefit of greater productivity will pass almost exclusively to shareholders. This will create a great shift in purchasing power away from Main Street towards Wall Street, and is one reason why the banks are doing very well at present.

The Conference Board has analyzed the European experience, which tells a very different story with regard to productivity.

There the drop in hours worked was much smaller at 3.1%. The European labor market is much less flexible than ours and it is often both time consuming and expensive to fire workers. So the rise in unemployment from the beginning of 2009 to it end was only 1.9%. The result was that European productivity actually fell over the course of the year – by 1.1%. Add this to the drop in hours worked, and the resultant drop in GDP ends up to be higher than that of the US at 4.2%.

So by protecting its workers, Europe settled for a sharper contraction and drop in profits, while the US went for less of a drop and a recovery in profits.

In theory this difference should help propel the US out of recession faster than the pace Europe will achieve, and it should enhance our ability to generate future wealth.

Oddly Europe has a much greater need to boost its productivity than we do. The expected decline in populations in places such as Italy imply, as a matter of arithmetic, that productivity must rise to offset the shrinkage in the workforce if current levels of out put are to be maintained. If productivity declines along with the workforce, then not only will the Italian population be older, it will be poorer. It will have less wealth available to provide for its retirees. Either that or its younger workers will have to allocate a much larger share of their own wealth to supporting the elderly. In which case they will experience a much lower standard of living than their parents.

Such is the importance of productivity over the longer run.

In the shorter run it is a very ambiguous number. It borders on the cruel. Our burst in productivity last year came on the backs of that extra 8.5 million unemployed.

So when we read of productivity increases we need to ask how that increase came about. Was it an influx of capital investment? Or was it due to the cutting back of the workforce?

We also need to concern ourselves with the harder question: how do we allocate the extra wealth a rise in productivity generates?

That’s the realm of politics, not economics. Maybe.