The Apparent Paradox of Productivity Growth

On the one hand, we see that increasing productivity can kill jobs -- in today's manufacturing sector 177 American workers can produce the same output that required 1,000 workers in 1950. One the other hand, productivity is viewed as central to job creation, as this article in today's FT notes:

The rate at which workers are raising their productivity in the world’s advanced economies fell by half in 2011, and is even starting to slow in some emerging economies, according to a report that suggests that unemployment is likely to rise in the months ahead.

According to the Conference Board, the global business organisation, productivity – defined as output per worker – in the most advanced economies fell from 3.1 per cent in 2010 to 1.6 per cent in 2011.

It turns out that decreasing productivity also kills jobs:

Bart van Ark, chief economist at the Conference Board, said that in the short term, the drop in productivity suggested that employers would cut labour to match the drop in overall output. “But in the longer term, productivity gains come from technology innovation and investment,” he said.

Moreover, there are concerns that the focus on austerity by governments may exacerbate the loss of productivity because without expenditure on new technology, any gains will be limited. “With calls for austerity, you have to be cautious not to cut the investments in new technology that increase productivity,” he said.

Read that again. If labor productivity falls, then businesses will eliminate workers, but over the longer term innovation will more than compensate for the short-term losses -- or at least that is the argument.

Even leading economists are of two minds on productivity. Here is Martin Wolf writing in 2005, extolling the virtues of productivity growth:

Productivity determines the wealth of nations. The proportion of the population at work matters, too, and so does the number of hours worked by each person. But neither is as important as productivity.

And here is Martin Wolf writing last summer extolling the virtues of productivity decline:

[I]f one is going to pursue austerity, as the UK government does, it greatly helps to have poor productivity performance. With US productivity, too, the UK would have a jobless rate of over 12 per cent.

On balance, I am grateful that the UK job market has responded to this recession in this curiously continental way.

By a "continental" response to the financial crisis Wolf means "a market that adjusts to shocks via hours worked per person rather than via jobs." So from this perspective, poor productivity performance is a consequence of decisions about how to spread the pain of an economic crisis.

But labor productivity is only one element of total productivity -- other factors matter as well. An economy can weather declines in labor productivity -- even those that are self-imposed -- if total factor productivity continues to increase. Wolf's apparently contradictory statements can be reconciled if we understand that in 2005 he was referring to total productivity and in 2011 he was referring to labor productivity. On his blog I am going to strive to be very clear about what I mean by "productivity" when I use the term.

Understanding the modern economy requires making sense of the easily confusing concept of productivity and how it relates to jobs and economic growth. [Total and especially labor] productivity growth does indeed kill jobs, but it creates jobs as well. Creating a virtuous cycle of total productivity growth is a key challenge of managing the 21st century economy.