Credit where it’s due

Written By: Steve Pierson - Date published: 12:04 pm, November 19th, 2008 - 30 comments
Categories: economy, Media, national/act government, wages - Tags:

It’s exam season for high school students. So, for 10 points explain how the following statement (in the ACT-National agreement and repeated uncritically by the media) can be true,

closing the income gap with Australia by 2025… will require a sustained lift in New Zealand’s productivity growth to 3 per cent a year.

given:
– productivity is just one factor in GDP (production = inputs x productivity, basically the amount produced depends on how much you put in times how much you get out per unit of what you put in)

-productivity growth tends to move in the opposite direction to the amount of labour and capital input growth – ie. productivity actually usually increases faster when GDP growth is slack or after a recession and productivity growth slows when GDP goes through a sustained period of rapid growth

– incomes (ie. wages and salaries, the price of labour) is a result of supply and demand for labour, not the productivity of labour. Indeed, wages usually increase fastest when there is a shortage of labour and rising demand while productivity increases fastest when there is an abundance of labour and falling demand (because only the ‘highest quality’ labour is used).

For extra credit: why is it that the supposedly economy-focused political parties and the business/political media seem to lack a fundamental understanding of economics?

[Update: I should add that I am not, of course, against productivity growth. I am just against people buying the idea it is some kind of panacea. There are very good reasons why the Right has chosen to focus on productivity: every other metric of economic performance has been too good. We have outgrown our trade partners, unemployment has ben at record lows, and wages risen have risen at record rates. Productivity growth is counter-cyclical, slow when the economy is at full tilt, so it has been a useful stick to hit a government in good times. It is also useful because it can be claimed, usually without evidence, that government regulation -ie work rights – is impeding productivity; if you wnat to remove work rights, first argue we need faster productivity growth]

30 comments on “Credit where it’s due ”

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Tane 1

19 November 2008 at 12:14 pm

Because they can use productivity as an exuse to slash “rigid” and “inflexible” labour laws and “compliance costs” like health and safety laws, consumer protections and community democracy in the RMA?
Lampie 2

19 November 2008 at 12:19 pm

and help Telecom gain an competitive edge by increasing broadband speeds
the sprout 3

19 November 2008 at 12:26 pm

ooh ooh, i know the answer for the bonus question!

because you don’t need to know anything about politics, business or economics to cut and paste from a press release. and if you were, like, a real journalist and did know about any of those things you might cost too much to hire, and the msm might not be able to keep making massive profits for its overseas owners.
Tane 4

19 November 2008 at 12:30 pm

sprout, top of the class.

Seriously though, we should all welcome higher productivity. It’s just I don’t think National and ACT see productivity improvements coming in the same way as I do.

Also, they seem to think productivity growth alone can lift wages when the reality is you actually need a mechanism to translate improvements into fatter pay packets – as we saw in the 1990s when productivity grew but wages fell, it doesn’t happen by itself.

National and ACT want to undermine, and in many areas remove, those mechanisms so the benefits of productivity growth go exclusively to the owners of capital.
Steve Pierson 5

19 November 2008 at 12:45 pm

Tane, as so often, hits the nail on the head. Productivity growth is great but if you want to lift incomes too you need mechanisms (ie work rights) to ensure that greater wealth flows through to workers.
Ianmac 6

19 November 2008 at 12:53 pm

I guess its OK to promise this sort of thing because the world will have changed by 2025. Maybe John Key will be retired by then 17 years hence. Isn’t there a promise about 2050 as well and that’s only 42 years hence.
Paul Walker 7

19 November 2008 at 1:33 pm

Steve The visible hand in economics went to some trouble to explain the basics of productivity here. Take a look. It will help.
Daveo 8

19 November 2008 at 1:34 pm

From what I saw they got a schooling from Robinsod.
Matt Nolan 9

19 November 2008 at 1:41 pm

“From what I saw they got a schooling from Robinsod.”

Really, then you must not of read my reply.
Steve Pierson 10

19 November 2008 at 1:45 pm

Paul Walker. I’m sure you can explain very easily how increasing productivity alone can close an income gap.
Matt Nolan 11

19 November 2008 at 1:50 pm

“I’m sure you can explain very easily how increasing productivity alone can close an income gap”

I’m not Paul but I can say:

Real income in the economy is the amount of goods and services that people can buy.

Increased productivity implies that we can produce more goods and services with the given inputs.

Therefore in the long-run (when inputs are appropriately utilised) higher productivity implies that higher income. It is a virtual truism.

Don’t get me wrong – I think that the goal of “productivity growth” is vacuous. However, it does not make that statement that higher productivity growth equals higher incomes wrong.

[“with the given inputs” is the problematic assumption. Any economic policy that focuses entirely on boosting productivity would actually want employment (ie inputs) to fall so only the higher quality inputs are being used. And we have the issue of which income gap we are talking about – if we’re talking about GDP per capita you’re right on the truism, if we’re talking the wage gap, and that’s surely what the ordinary person would understand by income gap, then we still have a problem SP]
Steve Pierson 12

19 November 2008 at 2:03 pm

This is quite long, so I’ll start by saying I am not arguing against productivity growth, I am arguing it is not a silver bullet. Important distinction.

I’ve just had a look at Matt’s piece in response to the first time I mentioned this issue. Hes talking about multi-factor productivity, not labour productivity as the National-ACT agreement seems to be. Also, you can’t get around the simple fact that productivity is a ratio – outputs:inputs and just because you improve that ratio does not mean you increase the amount of outputs.

I would be very interested to see the data that Matt alludes to saying productivity directly leads to wage increases, especially as wages having been increasing at a record rate despite productivity increase being slack because the economy has been overstretched. – let’s take a simple thought experiment:

We’ve got a cleaner, she can clean 5 fat cats’ offices an hour. Then her productivity increases, maybe she goes on a course or the give her e or the ‘wonder cleaner 5000’ or something. Now she can clean 10 offices an hour. Her productivity has doubled.

Will she get paid more?

Why would she? The cleaning company gets the money for the work she does, they get to decide how much of a slice she gets because the profits of her labour belong to her employer (its called capitalism). The cleaning company decides how much to pay based on what it thinks is the minimum it can pay to get enough, competent, happy-enough staff to do the job (it pays the minimum, because every dollar on wages is a dollar off dividends). Don’t matter that she’s got more productive, unless the market for her labour changes.

Now, productivity can change the market for labour overall. If all companies are getting more productivity from their workers, they’re more profitable and as they compete with each other for labour the amount they can pay will increase but it will depend very much on how many unemployed people are out there – if there are heaps, the cleaning companies won’t be competing with each other so they won’t need to offer higher wages.

So, and this is the experience of the 1990s, a worker’s productivity can increase dramatically but there is no reason, unless unemployment is low, that the increased wealth produced will flow through to that worker’s pay packet, and even low unemployment will only see some of the additional wealth flow to the one generating it. What does make wages go up is having workers able to group together and collectively deny their labour below a certain price and a minimum wage that means no labour can be suppled below a set price.
Tigger 13

19 November 2008 at 2:04 pm

Ugh – further to this topic I see Fran O’Sullivan frothing at the mouth over a Productivity Commission (would you like some bureaucracy with that?) and NACT adopting Douglasian principles.
http://www.nzherald.co.nz/nz-election-2008/news/article.cfm?c_id=1501799&objectid=10543789

Is the answer to the bonus credit question x = 5.37?
Matt Nolan 14

19 November 2008 at 2:18 pm

Hi Steve,

I had a look through the document before I posted and I didn’t see the National-Act agreement discussing labour productivity – infact it appeared more like a vacuous discussion of multi-factor productivity to me. Would you be able to point me to the specific page where they say labour productivity – if so I will update my post to say so.

“I would be very interested to see the data that Matt alludes to saying productivity directly leads to wage increases, especially as wages having been increasing at a record rate despite productivity increase being slack because the economy has been overstretched”

It is a fair question. The data I have worked with has been at my work, so I can’t really just pull that out and start throwing out my works intellectual capital. However, when I get a chance I’ll have a look around the free stuff at Stats and see if I can pull something together.

I agree that other factors influence real wage growth, but historically productivity has been a MAJOR driver – although I do not expect you to believe it till I come up with a graph 😛
Matt Nolan 15

19 November 2008 at 2:28 pm

“Any economic policy that focuses entirely on boosting productivity would actually want employment (ie inputs) to fall so only the higher quality inputs are being used”

No, no, and no.

We can boost productivity in a number of ways depending on the target. Say the focus is multifactor productivity, if we have increasing returns to scale then any policy to increase the size of the labour market, increase immigration, and eventually output will increase at a rate greater than the set of inputs being used.

The fact is that higher “productivity” in the general (total factor productivity) sense is invariably good – but is also not likely to something that can be magically provided by policy. Increases in TFP are the reason that economists assume that the economy can grow perpetually in per capita terms, however economists also do not believe that policy can really change the path of TFP – hence why such a goal is vacuous.

“And we have the issue of which income gap we are talking about – if we’re talking about GDP per capita you’re right on the truism, if we’re talking the wage gap, and that’s surely what the ordinary person would understand by income gap, then we still have a problem”

I agree there is a difference in so far as wage distribution is an issue (and terms of trade shocks). However, any criticism based on this only exists if the policy will increase wage inequality – at the moment we don’t have a policy to criticise so we can’t assume that 😛

“further to this topic I see Fran O’Sullivan frothing at the mouth over a Productivity Commission”

What the hell is the point of a “productivity commission” – sounds like pork to me.
Paul Walker 16

19 November 2008 at 2:49 pm

Steve. I have tried to make sense of what you have written here. If I am wrong what have I missed?
Draco T Bastard 17

19 November 2008 at 4:01 pm

An increase in productivity will result in a wage decrease unless there is a corresponding increase in demand at the same price. Assuming that the price is the market-price then there can be no increase in demand at that price so either of two things are going to have to happen.

1.) The price drops increasing demand for the extra production. This will only happen if the decrease in price results in greater profit. This may lead to an increase in wages if, and only if, the employer is feeling generous as he has no incentive to increase wages.
2.) The price remains the same, demand remains the same so the only thing that can happen is that the wage bill goes down

An increase in productivity should result in deflation. If wages stayed the same then there would be an effective wage increase similar to inflation being an effective wage decrease. Of course – the government and businesses will try to prevent deflation as it will result in a deflationary spiral. A major problem with our accounting/economic system is that $100 != $100.

What the hell is the point of a “productivity commission’ – sounds like pork to me.

It is but I don’t know why anyone would be surprised at that – it’s what right-wing governments specialise in.
Matt Nolan 18

19 November 2008 at 4:29 pm

“An increase in productivity will result in a wage decrease unless there is a corresponding increase in demand at the same price”

No. An increase in productivity shifts the supply curve right in the goods market – implying an increase in activity and a reduction in prices.

Wages won’t fall (as the marginal product of a worker is higher) – but unit labour costs will, as you need less labour to make a “unit”

“An increase in productivity should result in deflation”

Yes – if the quantity of money is unchanged.

…

Note that no-one ever said that an increase in productivity increase employment – we said that it increase the wage earned by a worker. The change in employment depends intrinsically on how the shape of the production function moves as the economy expands (for the mathematically inclined, I vaguely recall that we are looking for a homothetic production function if we want the composition of labour and capital to remain the same).

In the market overall, an increase in productivity increases the SUPPLY of goods – we can now make things with LESS inputs, that is what is so awesome about productivity growth. Now the distribution of these gains depends on the policy framework we have in place and, if you believe policy can influence productivity, the policies you implement to undertake this.

However, I cannot imagine an exogenous increase in productivity that reduces real wages – it makes no sense to me.
Lampie 19

19 November 2008 at 5:06 pm

just throwing this out there Matt, economies of scale, fits in here somewhere?
Mr Shankly 20

19 November 2008 at 10:26 pm

Why would a group that is so heavilly weighted down by the unions ever actually want to increase productivity. Unions are against performance pay or bonuses are against promotion based on an individuals performance or value to the organisation. Unions believe in evryone getting paid the same, unions believe in everyone being promoted at the same rate.

Steve P – A cleaner should be paid more for being more productive and cleaning more offices – but this is against everything labour and the unions stand for. I can guarantee if national suggests that a group of people get paid based on their performance in the public sector ie teachers getting more fo improving their classes average or lab staff having fewer errors and higher throughput – the unions would cry about how it is unfair, how it is discriminating etc etc.
Bill 21

19 November 2008 at 10:46 pm

Mr Shankly.

I worked a factory floor. And I’m a wee bit smart. So I figured out how my department could up output by 50%: cut material waste by between 80-90% in a way that us workers worked less. This amounted to many thousands of dollars.

It was demonstrated to management. It was a working proposition. What happened? Management jumped all over it, me and my workmate….refused to adopt the proposed production techniques and wound up making abut 20 workers redundant.

Then another 20 the following year.

Then shut down production and shipped it Australia….higher wages impacting on productivity because? Well my conclusion is obvious. Management in NZ is full of drop kicks who protect their own incompetence by promoting underlings who are even more stupid and unimaginative than themselves and stomping on anything and everything that might unmask them.

BTW. Not the only example I could outline, just the most obvious.
Mr Shankly 22

19 November 2008 at 11:03 pm

Bill – seriously if this actually happened get another job or better start your own business – rather than just blaming management.
Bill 23

19 November 2008 at 11:08 pm

It happened. That I don’t work there any more is incidental. It is a pattern and a mentality I have seen time and again in NZ. Incompetent management is the problem.
Mr Shankly 24

19 November 2008 at 11:12 pm

The argument could bemade that some unions behaviour encourages lazy management :). Again if people have a problem with their manager – leave – then the manager will very quickly get the message that he has issues and needs to change or leave him/her self.
Robinsod 25

19 November 2008 at 11:20 pm

Ah yes Shankly – the market will sort it out… Hasn’t sorted out that nasty rash of yours though, has it…

Oh and you write such godawful poetry too.
Bill 26

19 November 2008 at 11:38 pm

Mr Shankley.

Sure. Leave the job. Get another the same afternoon? Transfer accrued benefits (sick leave , redundancy)? Management what? Oh, that’s right….carry on the same old, same old.

G’night.
Mr Shankly 27

20 November 2008 at 7:57 am

Robinsod – i know you do not mean to be so rude but you must speak frankly.

People do need to be more proactive with their employment and if they don’t like what they are experiencing they should look at their options – this is something that generation Y understands quite well.

Bill one point I would make regarding management is often they are in a situation where they have limited ability to implement effective change this is in particularly true of government run organisations.
Carol 28

20 November 2008 at 8:43 am

Mr Shanky, it’s easier to measure productivity on a factory floor where you’re dealing with inanimate matter, and a lot harder to do that in teaching.

Relative success in education can be due to a load of variables that are not as easily managed, or even identified, as on the factory floor. In schools one class may have a lot of students, who have parents who didn’t succeed very well at school, and who can’t support them well at school. It may have many students with anti-school behaviours, who are disruptive in the classroom, or some with learning disabilities. And this all before a specific teacher takes iover the class. How do you compare that teacher’s results with that of a teacher of a class of students who are largely well-behaved/school conformist, and have aready achieved quite a lot academically?

Teachers also have to conform to a school ethos and procedures. If the school systems are at fault, this could distort results of “good” compared with “bad” teachers.

But even on the factory floor, I would have thought team work was as important as individual performance. Performance pay assumes that an individual’s work performance is totally down to them, and can’t easily take into account how a team operates together within agiven system. In fact, by giving incentives to individuals, it could work against achieving good team-work and/or improving the system.
Phil 29

20 November 2008 at 10:29 am

We’ve got a cleaner, she can clean 5 fat cats’ offices an hour. Then her productivity increases, maybe she goes on a course or the give her e or the â€˜wonder cleaner 5000â€² or something. Now she can clean 10 offices an hour. Her productivity has doubled.

Will she get paid more?

No-one’s bitten yet, Steve, so i’ll give it a crack.

The answer (which is the same to almost all economics-related questions) is “It depends…”

If the cleaner is now performing their job using a ‘wonder clean 5000’ (I’m assuing it’s some kind of machine or capital investment) then it’s unlikely she’ll get a payrise. If she does, it’s probably not going to be much.
Why? Because the improvement to productivity has come from a capital investment, requiring expenditure on the part of the company, and foregone opportunity cost of what that cash (or new debt) might otherwise have gone into. So, the benefits will go to the capital(ist).

On the other hand, the cleaner gets some kind of training, or goes on a course, or just through experience on the job picks up productivity ‘via osmosis’. Where does the new profit go?
Again, it depends. If the company sponsored/payed the employee to go on a course, it’s the one taking the financial risk (if the course isn’t any good, and the cleaner doesn’t learn anything new, does she care? did she pay for it? No skin of her nose) so should again, logically, get the primary benefit of the reward.

On the other hand, lets say the productivity increase comes from the cleaners own skills and experience. What then?
In this case, the cleaner has a strong case for recieving the bulk of the financial reward. In effect, she is now offering a differentiated product to labour market ‘buyers’.

—

You also mention Labour productivity growth in the 1990’s. Remember than post-84, the financial markets opened up, and it became easier for companies to borrow. This made it an awful lot easier to fund capital investment – an important input into productivity gains. At the same time advancements in IT became marketable to SME’s for the first time. These things are going to push up labour productivity, and the risk/expenditure is all on the capital side.