The Importance of Productivity Growth

Since efficiency and productivity are related ideas, and in fact one need to establish the productivity of the entity studied before efficiency can be determined, the following discussion proceeds by discussing productivity growth as the immediate target of the entities under investigation, meaning countries. It is understood that the countries with the highest productivity value are the most efficient entities hence, they form the efficiency frontier.

Thus, the importance of productivity growth does not contradict that of increasing efficiency, as the benefits are the same.

4.4.1 At economy level

Productivity growth is a desired feature for any production entity. In this case the entity may be a country, industry, firm or even non-profit making organization. To illustrate the productive growth at country level in order to provide an easier understanding to the subject, the definition of productivity used as proposed by Parham (n.d.) follows.

The simple definition of productivity growth can be given as the increase in output in a production system that cannot be accounted by an increase in inputs. This definition can be mathematically shown as:

Productivity growth = output growth – input growth

If the equation is rearranged in favour of output growth, it becomes Output growth = input growth + productivity growth

Hence a fundamental truth on the production of goods and services can be derived as follows: output can be increased by increase of input, similarly output can be increased by productivity growth. Output can be number of output units, sales or GDP. Figure 4.4 illustrates the concept.

Figure 0-4 Effect of productivity growth on output growth

Thus, countries can attain a higher GDP (as a measure of output) by increasing input, but similarly as a direct effect of productivity growth.

Also increase in GDP has an effect on people’s incomes.

Consider the following:

۵۲۾

۾

=

×

Whereby P represents the population size and H represents the hours worked

The first term in the equation ۵۲۾ ۾⁄ indicates the country’s income, while the second term, ۵۲۾ ۶⁄ stands for labor productivity, while the last term ۶ ۾⁄ represents the hours worked per person in the economy. The measure hours worked per person is a very inelastic measure since it only changes slowly, given that time is always limited and the working population changes rather slowly. It can therefore be concluded that labour productivity has a higher effect on increase of income.

Thus, productivity growth can benefit countries by expanding the economy through increasing output, as well as increase in personal income. These effects will lead to a society that is able to meet its needs (The Parliament of the Commonwealth of Australia, 2010), increase individuals’ sense of worthiness (de Brouwer, 2010), and lead to a better quality of life (Gruen, 2012).

At a country level, the benefits of increased productivity in the economy tend to have an unnoticed impact in the short term; however, in the long term they tend to be the basis of the economy’s productivity (Krugman, 1992;

Blinder and Baumol, 1993). The main reason for such an observation is that productivity growth is a manifestation of various economic forces that should be happening in the underlining economy. Some of these forces that support productivity growth include technological advancement, increasing quality of human resources, improved processes and efficient organizational systems.

Thus, when these factors improve, over time the economy tends to experience a sustained growth.

4.4.2 At industry level

Setting aside temporarily the economy-wide benefits of productivity growth, the benefits can vary between industries within the country. Mainly, industries benefit from productivity growth through increased and sustained competitiveness. This can be observed in two ways. First, within a country one industry may be experiencing higher productivity growth compared to others. Second, at the international level within the same industry, some countries may experience higher productivity growth than others. Increased competitiveness is mostly attributed to the achieved level of productivity and subsequent productivity growth. For an industry increased competitiveness implies that the industry is sustainably profitable, can retain and has the ability to attract highly skilled labour. Such industries often make

disproportionately large contributions to the economy, a trend that tends to guarantee favourable policies from the government for said industries.

4.4.3 At firm level

Perhaps the exact benefits of productivity growth are more often observed within the firm context, and are then propagated to the industry and economy levels. Understanding the benefits of productivity growth within a firm, where the most practical venue of strategic operations is, is important in understanding the reasons entities have to pursue productivity growth.

Although the theory is robust on the benefits of productivity growth to different stakeholders of the firm, there is limited empirical evidence. Most empirical evidence is aided by, but not limited to, the Lieberman and Balasubramanian (2007) study, referred to as LB in the rest of the section, which investigated the distribution of benefits of the firm’s productivity growth among firm’s stakeholders, using Toyota and General Motors (GM) as case studies for the periods 1978 – 1988 and 1988 – 1998. In these periods Toyota experienced productivity growth of 72 percent 1978 – ‘88 and 47 percent in 1988 – ’98, which were related to firm’s value expansion of 151 percent and 66 respectively. At the same time GM experienced 6.2 percent and 0.4 negative productivity growth scores, which corresponded with value destruction at 3 percent and 38 percent in the same periods respectively.

Since the emphasis is on the merits of productivity growth, only the Toyota results of the LB study will be described in further detail; however, GM results support the main arguments controlling for other factors.

The following describe the merits of productivity growth in a firm

Increase in wages. This is the most expected result of productivity growth, mainly because, as illustrated earlier at economy level, in the long run labour productivity growth will tend to increase output hence, the value created by the firm. Therefore, in firm settings, companies that improve

their productivity expand the value created by the firm which is then distributed to workers in higher wages. LB found that due to productivity growth in Toyota, wages increased by 15 and 16 percent in the first and second period respectively.

Consumers benefit from cheaper products. In fact, productivity growth happens when the firm is capable of producing the same product using fewer resources, or producing more goods and services given the inputs. This means productivity growth leads to higher profit margins for the firm.

Thence, the firm has more room to appropriately reduce prices to attract more consumers, at the same time remaining profitable. LB found that consumers of Toyota brand cars benefited at approximately 17 and 25 percent price reduction for the first and second period respectively.

Investors, or owners in general, benefit from higher capital gains and increases in the firm’s value. The fundamental obligation of the firm is to create profits for its owners through legally allowed operations, and in so doing serve other constituents in society. Generally, as a firm becomes more productive, its capital rate of return increases as well. Thus, owners or shareholders gain more value as the firm increases its profit and value. LB found that Toyota shareholders experienced 17 and 12 percent in capital gains related to the firm’s productivity growth.

Further, governments collect more taxes from companies that increase their productivity as they are able to generate higher profits for extended periods.

LB found that the government of Japan benefited from an increase of 22 percent in taxes in the first period, which is the highest increase in benefits of Toyota’s productivity growth in the periods investigated. However, it should be noted that government taxes contracted by 7 percent in the second period, perhaps due to a special arrangement with the government or changing in the structure of the firm and its tax obligations as it expanded.

Nevertheless, the main claim remains that productivity growth in firms is

likely to benefit government in higher taxes. And as Perham (n.d.) pointed out, increased taxes allow the government to fund more social programs such as education, health and other social infrastructures which in turn improve people’s wellbeing, and sustained and inclusive prosperity of society.

Last and often forgotten, productivity growth in firms reduces economic waste as well as environmental waste. Most firms’ inputs such as energy, minerals or timber are derived from the environment where sources are sometimes irreplaceable, or take a long time to replace, and there are climatic and other environmental repercussions to this. In most cases, the argument of environment protection comes at embedded social cost that usually traditional firms escape from paying. However, taken from the view of productivity growth, the fact that the firm can pursue more output out of the same environmental goods positively contributes to society. The European Commission analysed economic opportunity of “efficient” use of bio inputs and best practice processes in food and drink manufacturing, fabricated metal products, and the hospitality and food services sectors (European Commission, 2013). The report found that each of these sectors, in the same order, could have an annual efficiency benefit in the following ranges: Euro 64-118, 44-82, and 18-43 billion which translates to an average turnover growth of Euro 424,000 (11 percent), 164,000 (17 percent) and 27.5 (10 percent) respectively. It is important to note that the discussion is not to avoid using bio input, rather than a process tied to productivity growth benefits by using them while striving to attain the highest possible value.