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Economy in Brief

Post-Pandemic Productivity Promises
by Andrew Cates  August 20, 2021

Many economists are presently doing a lot of head scratching about the prospects for productivity growth. They are right to do so. Paul Krugman's oft-quoted adage that 'productivity isn't everything but, in the long run, it is almost everything' is as true today as it was when he offered this sage advice nearly 30 years ago. Productivity growth will hold the key to how sustainable global growth is likely to be in the face of post-pandemic economic, policy and financial market pressures.

So what are the prospects for productivity growth? As ever this depends on which country or region is being assessed and over what time frame. But there are a number of factors that are potentially positive for the productivity outlook in many of the world's major economies in the immediate years ahead.

Firstly, productivity growth has already picked up pace in a number of major economies in recent months (see figure 1). To be sure there are some cyclical reasons for this that concern shifting sectoral spending patterns as well as the slump and subsequent rebound in economic activity that has unfolded as the COVID crisis began and then matured. Nevertheless, the strength of the current rebound in productivity growth is still impressive. And one reason for this could be that corporate investment activity has also been impressive, particularly in the technology space (figure 2). Many CEOs and CFOs, moreover, expect to maintain high investment in this space in the period ahead (figure 3). A survey by the World Economic Forum conducted during the course of 2020 and published last October, for example, indicated that between 85 and 95 percent of firms were accelerating or looking to accelerate the digitization of work processes as a result of COVID-19.

Figure 1: Productivity growth in the US, Euro Area and UK has picked up pace

Figure 2: US investment in information processing equipment has been strong in recent quarters

Figure 3: UK investment intentions, particularly in the technology space, have firmed

Secondly - and a key driver of this additional capex - the COVID pandemic has generated shifts to behaviour that have necessitated an acceleration in digitization and automation. The modus operandi of many companies (as well as many households) has changed. As a result of this, potential productivity efficiencies that were lurking beneath the surface prior to the pandemic have been uncovered and magnified far more swiftly than might have been expected in the absence of the pandemic. The most obvious example of this is the breakthrough vaccine technology that was uncovered to fend off the virus, technology that may well trigger further efficiencies in health care in the coming months. But examples abound too in other areas of the healthcare sector (via online consultations), in construction (via the adoption of digital construction methods), in information and communications (via increased demand for digital services such as cloud computing and videoconferencing facilities), in retail (via an acceleration of e-commerce activity – see figure 4), and in banking (via a shift to digital channels and contactless payments).

Figure 4: The share of internet sales in total retail sales in the UK has soared to levels that would have been unimaginable prior to the pandemic

That brings us neatly to the next factor, namely the sheer number of new technologies that could yield a productivity dividend in the period ahead. Sure, there has been much hype about these technologies in recent years with many even suggesting (somewhat prematurely) that they earmark the advent of a fourth industrial revolution. Everything from artificial intelligence and machine learning, biotechnology, nanotechnology, robotics, and 3D printing have been touted as "the next big thing." Still, the sheer number of these intriguing technologies and the degree to which the pandemic may have now lit their fuse is potentially promising for how productivity growth evolves from here.

It's important to note here, however, that the absence of a broadly-based productivity revival in the pre-pandemic years may have had little to do with technology. The reason instead could be linked to surplus labour market capacity and low real wages. A growing body of evidence increasingly suggests that low real wages played a significant role in driving productivity growth to weaker levels in the years after the financial crisis (see figure 5) and prior to the pandemic. In other words when real wages were low and profit margins were high, firms had few incentives to deploy new technology and/or seek alternative ways of securing cost efficiencies.

The parallel view here is that low labour productivity growth in those years leading up to the pandemic may have simply been a symptom not of weak technology investment but of demand-constrained, cheap labour economies. Equally on this view it may now be no coincidence that labour productivity growth is rebounding as fiscal and monetary policy have been highly stimulative and as wage inflation has started to climb. Indeed with sources of labour supply not now as fertile as they used to be (thanks, for example, to de-globalisation and enduring pandemic-related restrictions) firms are arguably now more actively choosing to invest in and deploy new technologies that have a productivity dividend.

Figure 5: Weak labour market bargaining power may have restrained US productivity growth in recent years

So what does all this mean for productivity trends going forward? As stated above many US economists have been scratching their heads about this for a while now. And the median forecast from the survey of professional forecasters for the 10-year ahead growth rate of labour productivity has lately been lifted from a low of 1.35% in 2019 to 1.75% in the latest survey for 2021 (figure 6). In the view of this scribe, trend productivity growth in most major economies – the US, Euro Area, the UK and Japan – might improve by 0.5 to 1 percentage point over the next several years. That would be in tune with evidence from some academics and from surveys of CEOs and CFOs. It would additionally be sufficient to bring productivity trends in the OECD roughly back to where they stood prior to the financial crisis.

That upbeat productivity view, however, is still heavily contingent on a number of factors, not least of which is economic policy. A firming supply-side trend requires ample aggregate demand in order to fend off financial imbalances and mitigate dis-inflationary pressures. Policymakers therefore need to be highly alert to these in their judgements about managing monetary and fiscal policy.

Figure 6: US forecasters have lifted their estimates of trend (10 year ahead) productivity growth of late

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References

Will productivity and growth return after the COVID-19 crisis?, McKinsey Global Institute, March 2021.

The secret of productivity growth is not technology, World Economic Forum, Carlsson-Szlezak and Swartz, 3rd August 2021.

Artificial Intelligence and the Modern Productivity Paradox: A Clash of Expectations and Statistics, November 2017.

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.

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