Benefiting from the Next Production Revolution

NAECAlistair Nolan and Dirk Pilat, OECD Directorate for Science, Technology and Innovation

The production of goods and services has been transformed in many ways over recent years. First, production increasingly takes place across borders, in global value chains. Second, production is increasingly knowledge-based and involves a mix of goods and services, a phenomenon also known as the “servitisation of manufacturing”. Third and closely related, a growing part of production, in particular in the services sector, is affected by digitalisation and can sometimes be delivered through digital means. And finally, a new wave of technological change is now fundamentally altering the nature of production, heralding what has been referred to as a next production revolution. Ensuring that these transformations support overall growth and wellbeing requires sound policies in many areas and is a current focus of OECD work.

Global value chains. Over recent decades, the world has witnessed a growing movement of capital, intermediate inputs, final goods and people. Technological progress and innovation, notably in transport and communication, alongside trade liberalisation, have led to the fragmentation of production across borders and across tasks. Goods and services, and their components, are produced and assembled in different locations, often geographically clustered at the local and regional level, before reaching their target markets. This partitioning of production in global value chains (GVCs) has drawn attention to the role of different stages in a GVC to overall value creation. Indicators derived from the OECD-WTO Trade in Value Added (TiVA) database point to the growing importance of global value chains for international trade and production, and point the heterogeneity and complexity of trade flows in these GVCs. Whether for domestic or international consumption, the increasing reliance of production on intermediate inputs produced elsewhere stresses the need for countries to act so as to exploit their comparative advantages and fully benefit from GVCs.

Knowledge-based capital (KBC). At the same time, sustained competitive advantage in production is increasingly based on innovation, which in turn is driven by investments in R&D and design, software and data, as well as organisational capital, firm-specific skills, branding and marketing, and other knowledge-based assets. Generating higher value-added largely hinges on the (continuous) development of superior and often firm-specific capabilities and resources. These are frequently intangible, tacit, non-tradable and difficult to replicate. Investment in KBC has become an important driver of success in GVCs. Much value creation occurs in upstream activities, such as R&D, design, and the manufacturing of key parts and components, as well as in downstream activities, such as marketing, branding and customer service. OECD countries increasingly specialise in developing ideas, concepts and services that are related to the production of physical goods, and less on the production of physical goods as such. As physical production has increasingly relocated to emerging economies, manufacturers in OECD countries rely more on complementary non-production functions to create value, using KBC to develop sophisticated and hard-to-imitate products and services.

The digitalisation of the economy and society. Important as they are, KBC and GVCs would not have provided the opportunities they have without the rise of digital technologies. These have triggered deep changes in economy and society and enable strong productivity gains. It is not just the digital sector which makes a difference, the Internet and other digital technologies are now ubiquitous and underpin economic activities in all sectors. The innovations spurred by digital technologies hold huge potential for boosting growth and driving societal improvements, including in such areas as public administration, health, education and research. For example, the creation of large volumes of data and the ability to extract knowledge and information from them (“big data”) is initiating a new wave of (data-driven) innovation and productivity gains. The analysis of these data (often in real time), increasingly from smart devices embedded in the Internet of Things, opens new opportunities for value creation through optimisation of production processes and the creation of new services. This is what some dub the “industrial Internet” as empowering autonomous machines and systems that can learn and make decisions independently of human involvement generate new products and markets.

The Next Production Revolution. As the global economy continues to transform, new technologies mix and amplify each other’s possibilities in combinatorial ways. Many potentially disruptive production technologies are on the horizon and some are already starting to have an impact, e.g.:

  • Data analytics and big data increasingly permit machine functionalities that rival human performance.
  • Robots are set to become more intelligent, autonomous and agile.
  • Synthetic biology, still in its infancy, could become transformative, for instance allowing petroleum-based products to be manufactured from sugar-based microbes, thereby greening production processes.
  • 3D printers are becoming cheaper and more sophisticated. Objects can now be printed (such as an electric battery) that embody multiple structures made from different materials.
  • Bottom-up intelligent construction and self-assembly of devices might become routine, based in part on greater understanding of the principles of biological self-construction.
  • Nanotechnology – which uses the properties of materials and systems below the 100 nanometre scale – could make materials stronger, lighter and more electrically conductive, among other properties.
  • Cloud technology is enabling the rapid growth of Internet-based services.

The precise economic implications of these and other near-term technologies are unknown. But they are likely to be large. These new production technologies will be able to significantly boost productivity, particularly if they can be diffused across less productive firms and support an inclusive growth process. New technologies could also make production safer, as robots replace humans in the most dangerous manufacturing tasks. New production technologies also hold the promise of cleaner production and the creation of an array of products that could help meet global challenges. For instance, facilities producing bio-based chemicals or plastics could help to address environmental and waste issues and generate new jobs.

Challenges for policy. At the same time, various barriers might hinder the potential impact of the next production revolution on productivity, growth, jobs and wellbeing. For one, there is still a low level of digital technology adoption in most businesses, preventing realisation of their full potential. And enabling the next production revolution is not only about technological change: benefiting from new technology also rests on the ability of firms, workers and society to adjust to change, and on government policies that ensure that this transformation is inclusive and yields broad-based gains across the population. Organisational change, workplace innovation, management and skills are some of the areas where firms will need to invest to support rapid technological change, supported by complementary public investments in education, research and infrastructure. Enabling resources to flow to the most productive and innovative firms is also essential. Trust will also be critical to maximising the social and economic benefits of the digital economy. And, as our dependency on digital technologies increases, so too do our vulnerabilities, making on-line security, privacy, and consumer protection ever more essential.

The more governments and firms understand the implications of new technologies for production, the better placed they will be to prepare for the risks, shape appropriate policies, and reap the benefits. The OECD is therefore undertaking work on possible developments in production technologies, and their risks and opportunities, so as to help policy makers and business leaders realise the benefits and minimise the costs of the next production revolution.

Useful Links

OECD work on innovation in science, technology and industry

Rock star economy or one hit wonder?

Image: Guy Body / New Zealand Herald, used with permission
Image: Guy Body / New Zealand Herald, used with permission

Today’s post is by Paul Conway, Director of Economics & Research at the New Zealand Productivity Commission. Paul previously spent six happy years in the OECD Economics Department.  

The broken record of recent years, “Global Financial Crisis”, is finally giving way to a classic hit about long term prospects. While it is good to see the gradual strengthening in economic growth, there is still the major challenge of lifting the long-run drivers of growth and living standards, especially given the “grey bump” of population aging in developed countries. Productivity is the most important of these drivers.

A new paper written by the OECD Economics Department and published by the New Zealand Productivity Commission challenges the way we traditionally think about lifting productivity. This paper looks at the case of New Zealand and shows that the conventional explanations of investment in physical capital and years of schooling don’t explain New Zealand’s sizable productivity gap. Yes, these are still key areas with room for improvement. But the paper points to new avenues for increasing productivity, which will have important consequences for policymakers throughout the OECD.

At the start of this year, HSBC described New Zealand as a “rock-star” economy, with growth set to outpace most developed country peers, partly due to ongoing terms of trade increases and the Christchurch rebuild following the 2010 earthquake. Labour productivity has also improved over the last few years and we have a high proportion of the workforce employed overall.

But the bigger picture remains a concern. Labour productivity growth throughout the 2000s and post-Global Financial Crisis has been low in international comparison despite a sizeable gap in productivity levels.

As the paper shows, New Zealand’s broad policy settings should generate GDP per capita 20 per cent above the OECD average, but the actual result is more than 20 per cent below average. We may be punching above our weight, but that’s only because we are in the wrong weight division!

According to the OECD, New Zealand has reasonably good policy settings, and ranks towards the top of the class on product market regulation and other indicators. Our paradox is that this hasn’t been translated into productivity performance. Canada and Denmark are in a similar situation. It seems that some of the conventional reasons for poor productivity, such as a lack of investment in physical capital or low average education, can’t fully explain what is going on.

Instead, the paper points the finger at our weak international connections, which account for over half of New Zealand’s productivity gap relative to the OECD average. New Zealand firms face reduced access to large markets and limited participation in global value chains, where the transfer of advanced technologies now often occurs. Indeed, global value chains – which can require intensive interaction and just-in-time delivery across borders – may have worsened the impact of New Zealand’s geographic isolation on trade in goods.

Most of the rest of the New Zealand’s productivity gap reflects underinvestment in knowledge-based capital. In particular, R&D undertaken by the business sector is among the lowest in the OECD, reducing the capacity for innovation and the ability of firms to absorb new ideas developed elsewhere. The quality of management is also low, with poorly run firms surviving for longer than they would in more competitive economies. This reduces the ability of firms to adjust and extract maximum productivity gains from new ideas and technologies.

These reasons for New Zealand’s poor productivity track record are interrelated – international connections and innovation go hand-in-hand. To overcome the tyranny of distance, we should be harnessing ICT and creating the ideal conditions for knowledge-based companies to grow and participate in global value chains. The cloud-based accounting software provider Xero is a good example of the new business model which can succeed in global markets.

Knowledge-based capital now plays a larger role in production than ever before. But as Alain de Serres, Naomitsu Yashiro and Hervé Boulhol point out in their OECD paper, the challenge in harnessing the increasing returns of knowledge-based capital are considerable and the costs of policy mistakes may be increasing. Adding to that, New Zealand’s small size and great distance from international markets magnify the impact of any policy weakness.

The Commission was set up in 2011 to investigate specific issues relating to New Zealand’s productivity. Three years on, our experience has been that every time we conduct an inquiry – be it on housing affordability, international freight transport, local government regulation, the services sector, or regulatory institutions and practices – we discover considerable room for improvement.

The Commission is working on different aspects of New Zealand’s policy settings to improve productivity and wellbeing. With small domestic markets, New Zealand would benefit from greater integration into global value chains in innovation-intensive industries with fast-moving technological frontiers. That is easier said than done, but our small size means we can be agile and the window of opportunity for global economic integration irrespective of physical distance is slowly opening.

Useful links

An International Perspective on the New Zealand Productivity Paradox, New Zealand Productivity Commission Working Paper 2014/01, by Alain de Serres, Naomitsu Yashiro and Hervé Boulhol, OECD Economics Department.

New Zealand Productivity Commission

OECD Work on New Zealand