Wednesday, February 27, 2013

Productivity Is Very Important; Except When It Isn’t

Paul Krugman once said,

“Productivity isn’t everything, but in the long run it is almost everything.”

From a theoretical perspective, this is absolutely true. Every widely accepted model of economic growth from Solow onwards, has at its heart the concept of productivity. While you can get away with just adding inputs like capital or labour to increase output, sooner or later you run into diminishing marginal returns. In the long run then, the only source of real growth is productivity.

Intuitively, productivity is hardly controversial either – the more you make and sell from the same set of inputs, the more profits and wages and earnings you can make. Common sense, right?

That’s why headlines like this tend to scare people (excerpt):

MPC: Productivity levels much lower than those of benchmark countries

PETALING JAYA: Malaysians work longer hours than their counterparts in many benchmark countries, but produce less than them.

According to the Malaysian Productivity Corporation, our employee productivity levels are a lot lower than those of countries like the United States, Japan, United Kingdom, South Korea and Singa-pore.

MPC director-general Datuk Mohd Razali Hussain, citing the 2011 Productivity Report, said Malaysian workers had a productivity value of RM43,952 a year.

“But compared with Singapore, Hong Kong, Taiwan, South Korea, Japan and the United States, we are still far behind,” Razali said.

He added that the country was still recording an average productivity growth of 4.5% annually, which was lower than that of Indonesia and India.

Labour productivity levels are measured by the real gross domestic product over the number of workers in the country…

…According to the report, which analyses information from the Department of Statistics, workers in the top benchmark countries outperformed Malaysian workers almost six times over.

…In 2011, Malaysia had a productivity growth rate of 4.55%, which MPC said was on track for the country in becoming a high-income nation by 2020 with a productivity level of RM87,500.

However, Malaysians lost out to several benchmark Asian countries like China, which had a growth rate of 8.7%, Indonesia (5%) and India (4.8%)…

Cue complaints about low-wage foreign labour and poor quality employees.

Nevertheless, the essential point is that we are a middle income country because we have middling productivity levels. Logically therefore, to become a high income nation we need to improve and increase our productivity levels.

However…a funny thing happened on the way between theory and practice.

Productivity is actually bloody hard to measure, and there’s no single standard.

Take for instance the main metric used by MPC – real GDP per worker. Our income level (as measured by GDP) is lower than that of the benchmark countries because our productivity level (as measured by GDP) is lower. That’s tautological. It’s like saying Usain Bolt is the fastest man alive because he runs faster than anybody else. Um...doh!

But even when we look at some of the more advanced methods for calculating productivity, there is the issue of what we are measuring and why – the OECD manual lists five broad types categorised as single or multi-factor productivity and either at gross or value-added levels. As they say, the nice things about standards is that there are so many of them.

Productivity as a concept also has some practical issues, especially in the context of development and growth.

There isn’t that big of a problem when dealing with physical commodities or goods, such as in manufacturing or agriculture. While we do have an aggregation problem – if our production of apples increases 10%, is that equivalent to increasing our production of oranges by 10%? – there are broadly accepted methodologies for dealing with it, similar to how national accounts are compiled.

The main hurdle here is with measuring the output of intangibles i.e. services. Some services are standardised (think, an airline flight on a popular route), but many are not (think for comparisons sake, a private helicopter or jet service). That’s one reason why services output lends itself to being measured by its monetary value, rather than quantities. I might add that government services have neither a monetary measure or quantitative measure of output, which makes measuring productivity even tougher.

But this raises another problem – if demand is inelastic, even in just the short term, higher “productivity” can be achieved by simply jacking up prices. The more heterogeneous the service, the more likely demand will be inelastic – think Adele, or Daniel Day Lewis or Tiger Woods, then think of the price tag of getting these individuals to sing at your function, to act in your movie, or to appear in your golf tournament. For individuals with unique abilities or characteristics, demand can be very, very inelastic indeed.

But this increase in earnings doesn’t imply any increase in output in any qualitative or quantitative sense. For another example of this, think of the excess profits made by US and European investment banks in the run-up to the Great Recession. These would have appeared as “productivity” improvements insofar as GDP and earnings increased relative to the number of workers within that sector. But does anybody really believe that to be true?

More broadly, this measurement issue applies to most non-tradeable services – “productivity'” under these conditions loses a lot of its conceptual economic underpinnings as well as its intuitive meaning.

None of the above is to say we don’t need to worry about our level or growth rate of productivity. It is still a valid theoretical construct, and perhaps more importantly, an economic concept that is easily grasped by the non-technical public.

Just bear in mind that the aggregate productivity numbers generated by us or anybody else needs to be taken with a grain of salt and a prayer.

Technical Notes:

"Measuring Productivity: Measurement Of Aggregate And Industry-Level Productivity Growth", OECD Manual, 2001 (warning: pdf link)


  1. I guess now Solow and Krugman can be considered brain vacuumed s*&%heads given all those caveats and qualifications, you inserted regarding productivity...hahahahahaaha

    Seriously though, given the ethereal nature and complexity of the stuff, I am just curious as to how much does productivity really helps the economy. Lets assume that it takes 10 guys to chop down a tree in an hour with an axe but just 1 guy with a chainsaw to down 10 trees in that hour. You see, automation ( aTFP component) would spike productivity but the flipside of it is that it renders 9 guys redundant (unemployed). Imagine that simple example being repeated across manufacturing and even the service (think an airline using technology to take out the human in everything from purchasing to checking in). Yep, you might argue that the work of producing, installing, programming all that automation will create higher salaried jobs of their own. And in the long run, machines can churn out output without the need for rest breaks, Socso, and stuff lowering production costs (yep, agreed they would have breakdowns, maintenance etc) but the net effect is still automation will lead to fewer jobs but perversely higher paying jobs that perversely require better quality education blah blah blah that thankfully leads to better living standards , right? Wrong:

    Alternatively, the existence of cheap labour is a disincentive to automate and which contributes to a lower quality of life all around save for the exploitative capital class (who are from a certain ethnic group in Malaysia) who pay 'slave era' wages while quadrupling their net gains in the casinos and speculative property marts of money laundering Singapork. Yep the very same ethnic now badgering the Malaysian government to rescind the minimum wage:

    Speaking of Singapork, interesting observations you made up there which i rehash here as:

    "For another example of this, think of the excess profits made by Singaporkian investment banks in the run-up to the Great Recession. These would have appeared as “productivity” improvements insofar as GDP and earnings increased relative to the number of workers within that sector. But does anybody really believe that to be true especially when Singapork is a known hub for moneylaundering and tax evasion?"

    moral: MPC should avoid mentioning Singapork whose own productivity gains have been declining for almost a decade: Declining Productivity Growth.pdf

    Warrior 231

    1. Warrior, you've pointed out one of the biggest hurdles in improving productivity - what do you do with the excess labour?

      The problem here is that there will be a gap between the new, high value-added jobs created and the low skills and capabilities of those superseded by automation. Some of that gap, but only some, can be covered by investment in reskilling and retraining. But this is expensive, and typically yields low returns.

      A tough problem.

    2. Yeah, its sort of a 'damn if you, damn if you dont' conundrum isnt it and more...for productivity improvements are inevitable so long as innovation keeps apace and man keep searching for holy grails to yield more dough with least possible input costs.....

      The American example is a classic case in point. Farm labour displaced by machination moved onto the factory sweatshops where initially brawn and sweat held sway but as technology upscaled itself, a generation or so later the poor fellas found themselves back in the streets.

      And the advent of the global supply chain has meant that they (the first worlders) lose out further as they cannot compete with third worlders in terms of wages. So what gives, agree to low wages and compromised quality of life in return for a job which puts everything back metaphorically at square one...funny isnt it......I would rather think this would have left many pink 'slippers' and those furloughed thinking the chase for the American dream or the wealth dream whatever is nothing more than a mirage after all...hahahahahaha

      Warrior 231

    3. Oil palm diesel a crime against rainforestsFebruary 28, 2013 at 11:48 PM

      "Alternatively, the existence of cheap labour is a disincentive to automate and which contributes to a lower quality of life all around save for the exploitative capital class (who are from a certain ethnic group in Malaysia) who pay 'slave era' wages while quadrupling their net gains in the casinos and speculative property marts of money laundering Singapork. Yep the very same ethnic now badgering the Malaysian government to rescind the minimum wage:"

      Thank goodness someone can see this exploitation of our resources. When UMNO government want to reduce poor slaves labour from coming to work in oil palm plantations, the chinese capitalists threatened they wont be able to service the bank loans. Hah?

      Now it seems that Malaysian banks are over exposed to oilpalm plantations. KUB is opening more native lands in Sabah. More rainforest acreage is being destroyed and allocated to oilpalm. More supply means lower price. It seems idiots are running the agriculture ministry and MOF.

      Banks should be stopped from opening new oil palm plantations as inventory is at record high. Then they are forced to burn these oil palm as diesel.

      So now Malaysia is burning food to run cars while our oil is still abundant.

  2. "what do you do with the excess labour?"

    what do we do when we have insufficient labour?

    1. Excess labour in KelantanMarch 1, 2013 at 12:04 AM

      "what do we do when we have insufficient labour?"

      UMNO must limit and specify the industries that can be opened in Malaysia.

      Labour intensive factories imported third hand from Taiwan is a big no no. They are dirty and manual intensive. You read in the STAR how a Chinaman brought over an old lubricating equipment and made it to work in Malaysia.

      Thats folks is how the Chinese has managed to pull one over UMNO. It is not that the migrant chinese are smarter than the Malays, they are in fact part of the greater China marketing arm. With their cousins/uncles providing them leads they brought over cheap China stuff and sell to the native Malays.

      But now given citizenship by Tunku they are exploiting rainforests/mines rivers on greater scale. Unless UMNO prohibits manual intensive factories from China, our country is going to get more polluted as an international study had shown.

      Mustapa Mohamed effigy, according to a Malay daily had been whipped by Kelantan Malays. This is symptomatic of incompetent politician. Mustapa proudly declared he is allowing 14,000 cheap labour for Chinese furniture factories in Johore and yet he is whipped in his own state by his own race! I guess after that he run back to KL to be embraced by the Chinese capitalists..hehe.

      You should forced furniture factories to upgrade and employ Malay Kelantanese at decent wages..Mustapa than the Kelantanese will love you.

      There is no lack of labour in Malaysia especially Kelantan, it is just greedy would be capitalists given the leeway to open dirty factories and industry by nincompoop leadership.

  3. Just wanted to thank you for today's speech. It's nice to be able to hear you speak in person after following your blog for several years. :-)

    1. Mamin,

      Thanks! I'm glad you enjoyed it.

  4. Hello HishamH. This reply is in regards to the concept of "excess labour" that exists after increases in productivity, as brought up by Warrior.

    Do you really believe this to be a problem as an Economist? Sure, there can be short term shocks to the system, but isn't this the price we pay on the path to a higher equilibrium level of consumption?

    As a spurious example, two islands, A and B, both with 20 people. A is inefficient, and it takes 10 people to gather food for everyone, and 10 people to build and maintain shelter against the elements. While B has 20 people and they are more productive, so it takes 5 people to gather enough food for everyone, 5 people to build and maintain shelter for everyone, and the excess labour, 5 of them make clothes, and 5 of them make luxury goods like wine and confections. Everyone would say that island B has a higher standard of living.

    Even disregarding all theory, we see in developed countries, say, Australia, how labour is used as sparingly as possible. Now, this could be a chicken and egg issue - is labour used sparingly because it's highly productive, or is labour used sparingly because it's too expensive to use normally, and it's expensive because wages are high because productivity is high. Maybe it's a circular feedback cycle.

    Just some of the more visible examples:
    1) Toll system: cars drive along the highway at 100kmph and the toll cost gets deducted automatically - more efficient than building and manning tollbooths 24/7, not to mention the waste of time and petrol. If we assume the total revenues from both highway systems are the same, the system that employs 10 people as opposed to 100 people is more productive per worker.
    2) Supermarkets: innercity supermarkets have as much as 80% of registers as "self checkout". This means that a single supermarket staff can supervise 8 lanes on their own, while I have seen in Malaysia, each checkout counter sometimes has even 2 staff (one to scan, one to pack). It's amazing how "lean" they run their operations - there's not a single staff walking the floor, there's no one to get any help from, a single staff falling sick is a major disaster, so attendance rates must be near 100%. But still, if you run two supermarkets with the same revenues, one with 8 staff and one with 30 staff, the former will be much more productive per worker.

    One could argue that in the second example, it's not really labour saving, it's shifting the burden of labour. That's an interesting idea, though, because the labour that they've gained is "free" (from the consumers) - it doesn't cost any time, in fact, it saves them time - having a huge bank of self checkout counters means queues are much reduced. It's a system designed to extract value from society for no cost. In fact, the argument could be made that GDP in countries with high utilization of manual labour (like Malaysia) could be overcalled versus countries with low utilization of manual labour (like Australia), making the gap even bigger. Consider that in Australia many more people cook for themselves compared to Malaysia. In Malaysia, going out to eat would involve other people's labour (chefs, waiters, cleaners) and thus be counted in national GDP, while in Australia, cooking on your own would be using your own labour and not be counted as part of national productivity.

    Despite having studied economics and working in finance (in an area related to international manufacturing) I realise no one really has an idea of how to build a roadmap to progress a nation from a low productivity state to a high productivity state. It's a complex question =\ I have an inkling that it's a chicken and egg scenario, as Warrior pointed out, if wages are eternally low, then no one has any incentive to find more efficient ways to accomplishing things.

    1. @aetherfox,

      Development and growth economics continues to remain in a state of flux - while there's a lot of consensus on the characteristics of a high income economy, there's far less on how to get there. Hence boogiemen like the middle income trap and the big push hypothesis continue to have traction in policy circles.

      As for your hypothesis regarding over- and under-valuation of GDP, I'm not sure if that's correct. On the one hand, what you say is perfectly true. On the other hand, to offset this, the informal economy in Malaysia would be many times bigger (this is empirically negatively correlated with per capita income), and also ignores issues with the price level (the problems related with service sector productivity I outlined above).

      Going from memory, there are some estimates that the informal economy in Malaysia not captured by GDP statistics, is about a third as large as the formal economy, while for most developed economies its under 10%.

      With respect to service sector productivity, there is an empirically tested regularity called the Penn effect which shows that higher income countries tend to have higher (i.e. more expensive) price levels.

      The prevailing hypothesis of why this happens boils down to the non-tradeable nature of services, and how increases in manufacturing productivity raises wages across the board. So there is some causality with growth and incomes inferred from improving productivity generally and manufacturing in particular.

      My concern with the whole notion, and with the concurrent idea of excess labour, is the intertemporal effects on labour of development and increases in productivity.

      If you posit that improvements in productivity require less labour, you can indeed reduce reliance on foreign low wage labour. That possibly increases domestic welfare but at the cost of external welfare - whether there's actually a net aggregate gain depends on the respective income and expenditure elasticities, and whether the wage share of national income stays constant (NOT a given). I think there's a decent argument here in terms of manufacturing, but not for services where "productivity" is more a function of price than of output.

      In reference to domestic labour though, higher productivity in manufacturing would free up labour for other sectors, but now we have the problem of a changing economic structure relative to existing labour skills - Malaysia is not a classical economy model where we can simply shift labour from one use to another without cost or friction.

      That will require investment in retraining and reskilling, a process that will be both expensive and incomplete i.e. we have to accept that the structural unemployment level is likely to rise. That's an issue that bedevils developed economies as well, but is more acute with developing economies where the pace of change is faster.

      I'm also concerned about the impact on income shares (a 40% gap between manufacturing productivity and wages has opened up in the last 15 years), but income inequality is another topic.

      It's a damned if you do, damned if you don't problem.

  5. As an employer, and being in service industry, i could not find a way to reduce labour with the increase of wages. So now i will have to either live with less profit or past the cost to customers. At the end of the day, it will be whether the demand side willing to pay more for the same supply.

    Zuo De

    1. Zuo De,

      Yes, sometimes we lose sight of the micro effects from just looking at the aggregate numbers. In the end, some sections of the economy will need to have price inflation, while other deflation.

      For whatever comfort it's worth, I see services sector price and wage inflation as a necessary condition for high income status.