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The Importance of Productivity

May 18, 2012 by Ike Brannon

Last week I discussed the nonsense emanating from various economic commentators who mistakenly assumed that the recent fall in our country’s measure of productivity is somehow good news for the American worker. I disputed that contention, pointing out that we’re no good at measuring productivity in the short run for a variety reasons and thus we should put little stock into short-term variations in it. But while the short-term measure of productivity may be flawed, the long-term measure is vitally important, and in fact is the most important determinant that we have of our standard of living. Without increasing how much each person produces in an hour of labor, there’s not much else we can do to improve our standard of living, save for having more people work, having them work more hours at their job, or having them retire later, all of which have inevitable constraints and come at an opportunity cost to those who like leisure more than their job — i.e. 99.95% of us.  (We can and should do all these too — but that’s grist for another day). So how can we improve productivity? The normal answers are to improve education, encourage more people to get college degrees, and lower the cost of capital and encourage investment. To the extent we can do such things we should, but ultimately the way to get productivity gains is to ensure that there’s competition throughout the economy. Bill Lewis, the founder of the McKinsey Global Institute and author of the seminal book “The Power of Productivity,” studied the productivity of the Western economies sector by sector and found that the biggest determinant in a sector — and a country’s — productivity was the amount of competition.  For instance, while Japan’s auto and electronics industry have productivity well above the U.S., in most other sectors they greatly lag U.S. industries. Most tellingly, the average retail worker in Japan is only 40 percent as productive as his U.S. equivalent, which Lewis blames on Japan’s cosseted retail sector. Lewis goes on to note that the retail sector is not just any old industry: Wal-Mart’s relentless push to improve productivity and profits has forced its myriad suppliers to do likewise, as well as its competitors. As a result, the gains to consumers from its efforts have been impressive: President Obama’s deputy director for the National Economic Council, Jason Furman, estimated in 2005 that the average consumer’s benefit from Wal-Mart’s presence and its ability to provide lower prices was nearly $2500 per annum. Lewis’s message is simply a boots-on-the-ground report of what the famed growth economist Paul Romer has said for years: investment in technology, plant and equipment, and education certainly matters, but having the right rules and incentives in place is a necessary precursor that can ensure that these necessary investments take place and are utilized by society. Wal-Mart benefited greatly from adopting RFID tags in their logistics; Japanese companies don’t do this because they’re small and wouldn’t see much of a gain from such an investment. Little of the economic debate of late has focused explicitly on productivity; to be fair to President Obama, it rarely does. But it is something that all of us who think about policy should keep at the forefront of our minds when judging various proposals to jump-start our economy.


Author

Ike Brannon
Ike Brannon

Ike Brannon served as an Economic Growth Fellow of the George W. Bush Institute from 2012 to 2015. He has a Ph.D. in economics from Indiana University and a B.A. in math, Spanish, and economics from Augustana College. View his full bio

Full Bio