The productivity and equality nexus: is there a benefit in addressing them together?

NAECGabriela Ramos, Special Counsellor to the OECD Secretary-General, Chief of Staff and G20 Sherpa

Productivity growth has slowed since the crisis and inequality has been getting worse. Could they be influencing each other?

The linkages between the productivity and inequality challenges are still to be fully explored. Each may have its own solution, but there is also good reason to think that there is a nexus between them. For instance, OECD evidence suggests that wage dispersion between firms, which reflects diverging rates of productivity growth, has contributed to rising inequality of incomes between workers. At the same time, the increased prevalence of knowledge-based capital and digitalisation may have unleashed winner-take-all dynamics in key network markets, which in turn may have led, in some instances, to an increase in rent-seeking behaviour.

OECD research has highlighted how the rise in inequality over the last three decades has slowed long-term growth through its negative impact on human capital accumulation by low income families.

Since the crisis, stalled business dynamics have seen resources, including workers, being trapped in firms where they are not using their full potential. In particular, individuals with fewer skills and poorer access to opportunities are often confined to precarious and low productivity jobs or – in many emerging countries – informal ones.

In the spirit of our integrated framework on inclusive growth and our New Approaches to Economic Challenges (NAEC) initiative, at the OECD we believe that our efforts to address productivity and inequality challenges could have a better chance of succeeding if we looked at the synergies and trade-offs emerging from policies to address them. This means designing policies for each of these two core issues bearing in mind how they might impact one another and avoiding the “silo” approach through more effective and comprehensive policy packages.

We must also learn from previous policies. Traditional measures to boost productivity in competition, labour market, or regulatory frameworks would allow for the reallocation of resources to more productive activities, or for increasing productivity in specific sectors. But this may have an adverse impact on inequalities of income and opportunities, as workers better equipped to cope with change are usually those with higher skill sets. For instance, in the past, the drive towards flexible labour markets has benefited many employers, and particularly the most productive firms that have gained from an improved allocation of labour resources. But increased flexibility has also brought a greater prevalence of non-standard work. Recent OECD work on job quality highlights how low skilled individuals can be trapped in precarious low wage jobs, and receive less training.

Our approach to designing policies to ensure that individuals, firms and regions that are left behind can fulfil their full potential and contribute to a more dynamic economy, draws on OECD work from diverse policy areas. It starts from the Inclusive Growth agenda, by focusing on well-being as an ultimate objective of policy. It builds on OECD productivity work via The Future of Productivity report and efforts Towards an OECD Productivity Network. It also synchronises with the Organisation’s efforts to measure productivity more accurately at a time when traditional measures are ill-adapted to account for the full effects of rapid technological change and innovation centred on knowledge based capital, the increasing prominence of the services sector, and productivity in the public sector.

The ultimate outcome is for governments to focus on the extensive range of win-win policies that can reduce inequalities while supporting productivity growth, thereby creating a virtuous cycle for inclusive and sustainable growth. This calls for distinct but complementary policy interventions at the individual, firm, regional and country levels. What this entails in practice will vary for each country depending on its circumstances. But broadly speaking, a number of policy areas are worth considering:

First, a new approach is needed to boost productivity at the individual level so that everyone has the opportunity to realise their full productive potential. Expanding the supply of skills in the population through more equal access to basic quality education is crucial, but not enough. With rapid technological change, skills need to keep up with the demands of the market to avoid the skills mismatches which have contributed to the productivity slowdown. A broad strategy is also needed to ensure a better functioning of the labour market, promote job quality, reduce informality, allow for the mobility of workers and inclusion of underrepresented groups such as women and youth, and promote better health outcomes for everyone.

Second, for people to realise their full productivity potential, businesses have to realise theirs. While heterogeneity among firms is normal, the widening dispersion in productivity levels and its implications for aggregate productivity and workers is a cause for concern. According to our productivity report, the early 2000s saw labour productivity at the global technological frontier increase at an average annual rate of 3.5% in the manufacturing sector, compared to just 0.5% for non-frontier firms. The gap was even more pronounced in the services sector. The larger the share of business that can thrive, the more productive and inclusive our economies will be. Achieving this requires a reassessment of competition, regulatory and financial policies to ensure a level playing field for new firms relative to incumbents. It also requires policies to facilitate the diffusion of frontier innovations from leading to lagging firms.

Third, policy prescriptions will be ineffective unless they take regional and local circumstances into account. Inequalities that play out in regions, like housing segregation by income or social background, poor public transport, and poor infrastructure, can lock individuals and firms in low-productivity traps. This means that some policies to promote both productivity and inclusiveness are best undertaken at the regional level.

Finally, adopting a more holistic approach to policy requires fundamental changes to public governance and institutional structure to strengthen the ability of national governments to design policy that promotes synergies and deals with trade-offs. In highly unequal societies, governments also need to address political economy issues including the capture of the regulatory and political processes by elites that benefit from the status quo, and policies that favour the incumbents.

None of this will be easy, but it is nevertheless essential. At the OECD we believe it is time to develop a better understanding of the dynamics between two of the key issues of our time – productivity and inequality – in order to build a more resilient, inclusive and sustainable future.

Useful links

OECD Inclusive Growth Initiative

OECD Centre for Equality and Opportunity

OECD Inequality webpage

OECD Future of Productivity

OECD Productivity Statistics

Making innovation work

Innovation imperativeDirk Pilat, Deputy Director, OECD Directorate for Science, Technology and Innovation

Today, innovation is central to advanced and emerging economies alike; in many OECD countries, firms invest as much in the knowledge-based assets that drive innovation, such as software, databases, research and development, firm-specific skills and organisational capital, as they do in physical capital, such as machinery, equipment or buildings. The use of information and communication technologies has become universal in only a few decades and new applications, for citizens and businesses alike, emerge daily. But while innovation is all around us, its impact on growth and wellbeing is not always very clear. Moreover, there are growing concerns about the disruptive power of innovation, notably its impact on jobs. Ensuring that innovation contributes to growth, jobs and greater wellbeing therefore remains a challenge, as does the application of innovation to policy challenges as diverse as climate change, health or the delivery of public sector services.

The new OECD report The Innovation Imperative – Contributing to Productivity, Growth and Well-being draws on work on innovation across the OECD and argues that policy makers can do better in marshalling the power of innovation. While firms make the bulk of the investments that drive innovation, government action is key to making innovation work for growth and wellbeing. Policy makers need to foster a sound environment for innovation across the economy; invest in the foundations for innovation, such as research, skills and knowledge infrastructure; help in overcoming critical barriers to innovation; and ensure that innovation ultimately contributes to growth and greater well-being.

One of the difficulties to making innovation work is that it relies on a mix of policies for innovation that go considerably beyond research and innovation alone. The precise mix will depend on the national and institutional context of each country, the level of economic and social development, and the prevailing barriers to innovation. It will also need to be adapted to the specific challenges of different sectors and policy areas, whether public or private, e.g. agriculture, energy, health, education or the public sector. A number of policy areas are particularly important across all of these:

Effective skills strategies: Innovation should ultimately contribute to increasing people’s well-being. It also rests on people that have the knowledge and skills to generate new ideas and technologies, bring them to the market, and implement them in the workplace, and that have the skills to adapt to structural changes across society. However, the OECD Survey of Adult Skills shows that two out of three workers do not have the skills to succeed in a technology-rich environment. A broad and inclusive education and skills strategy is therefore essential.

Development of a sound, open and competitive business environment that encourages investment in technology and in knowledge-based capital, that enables innovative firms to experiment with new ideas, technologies and business models, and that helps successful firms to grow and reach scale. However, policy – ranging from R&D tax credits to environmental regulations – too often favours incumbents, which reduces experimentation, delays the exit of less productive firms, and slows the reallocation of resources from less to more innovative firms. It also delays the introduction of breakthrough innovations in the economy, which is particularly problematic for areas in need of radical change, such as energy. Moreover, it tends to limit job creation: young firms account for over 40% of all new jobs in OECD economies and could probably create even more given the right policy framework.

Sustained public investment in an efficient system of knowledge creation and diffusion. Public investment in research is essential for innovation; most of the key technologies in use today, including the Internet and genomics, have their roots in public research. While such investment has held up reasonably well during the crisis, it is now declining in many OECD countries as these engage in fiscal consolidation and focus more on short-term benefits. As the world faces long-term challenges like climate change and ageing, now is not the time for policies for innovation to be driven solely by short-term benefits.

More balanced support for business innovation: OECD governments have increased their emphasis on R&D tax incentives in recent years, and these now amount to almost 40 billion USD across the OECD. Such incentives often do not meet the needs of young, innovative firms and risk amplifying cross-border tax planning by multinational firms. Better design can help, but governments also need to strengthen support through competitive and transparent grants as a complement to tax incentives. These are more suited to the needs of young innovative firms, can foster cooperation across the innovation system, and can be directed towards areas were government support can have the highest impact.

Increased access and participation in the digital economy. Digital technologies offer a large potential for innovation, growth and greater well-being and can affect also every part of economy and society. However, policy action is needed to preserve the open Internet, address privacy and security concerns, and ensure access and competition. Digitally enabled innovation also requires new infrastructure such as broadband, spectrum and new Internet addresses.

Sound governance and implementation, including a commitment to learning from experience. The impact of policies for innovation depends heavily on their governance and implementation, including the trust in government action and the commitment to learn from experience. Policies for innovation operate in a complex, global, dynamic and uncertain environment, where government action will not always get it right. A commitment to monitoring and evaluation of policies, and to learning from experience and adjusting policies over time, can help ensure that government action is efficient and reaches its objectives at the least possible cost.

Clearly, there is no magic bullet to strengthen innovation performance. However, concentrating policies on these areas for action will help governments in fostering more innovative, productive and prosperous societies, help increase well-being, and strengthen the global economy in the process.

Useful links

Data Driven Innovation: Big Data for Growth and Well-Being

OECD Science, Technology and Industry Outlook 2014

OECD Reviews of Innovation Policy offer a comprehensive assessment of the innovation system of individual OECD member and partner countries, focusing on the role of government. They provide concrete recommendations on how to improve policies which impact on innovation performance, including R&D policies. Each review identifies good practices from which other countries can learn.

Smarter, greener, healthier and more productive: The new old

A more cheerful outlook
A more cheerful outlook

Today’s post is by Tobias Vogt and Fanny Kluge from the Laboratory of Survival and Longevity at the Max Planck Institute for Demographic Research, Rostock, Germany

Ageing populations are a threat to the sustainability of modern societies. This is a dominant line of thought in the political, public and scientific discussion that warns us about the consequences of demographic change. It refers to the concern that the needs of an increasing share of older people have to be met by a decreasing number of younger members of our societies. These warnings must be taken seriously if current conditions prevail. The changes in the age structure will bring major challenges to public finances and the demand for an adjustment of current social policies, in particular, in countries with large public welfare programs for the elderly. Yet, the demographic future may not look as bleak as we generally think. The greying of a population may even embrace certain advantages simply because of the natural transformation of the age structure. This thought was the starting point for a, so far rare, project that focused on the potentials and chances of demographic change. In this case study (downloadable from PLoS One) we focused on Germany as the second oldest country worldwide in terms of its population’s median age of 44.3 years and identified five different areas that may benefit if observed trends of the past continue into the future.

To understand the anticipated challenges as well as the opportunities of demographic change one has to keep in mind that they only result from a change in the age structure of a population. If we depict the current age composition in Germany or in most industrialized countries, it looks rather more like a tree than the usual population pyramid. Yet, this illustration will also only be a snapshot as the over-represented older age groups will become smaller and eventually disappear in the coming decades. Despite ongoing low fertility and a general population decline, this will result in a more stable age structure after 2040 than in the decades when the large baby boom cohorts reach retirement age. In the last decades the share of Germans above age 65 rose by 2 to 3 percentage points. Between 2020 and 2040 this share of Germans will increase by 10 percentage points from 23% to 33%. In the following two decades it will remain stable at this high level and go up slightly.

One major concern of this population structure is that fewer and older individuals are expected to be less productive. This assumption ignores the fact that certain productivity determinants among older individuals like education and health will not remain constant but change over time.

During the last decades participation rates in higher education have increased from cohort to cohort which is reflected in the share of individuals in the labor force with tertiary education. In 2008, every fifth individual in the age groups 25-29 and over age 50 attained tertiary education. These shares will rise considerably. After 2050, every third individual in the respective age groups will have a tertiary education. If current labor force participation rates among these groups remain as they are, this would mean that 46% of the German labor force will hold a higher education degree compared to 28% today.

These changes in educational levels are accompanied by an improvement in individual health. Over the last 30 years, the age at which Germans report worsening subjective health has become later and later. If we forecast this trend into the future we find that not only average life expectancy as such will increase but also the number of years we live in good health. Already today Germans can expect to spend up to 60% of their life in good health. By 2050, this share will increase to 80%, which suggests that most of the years of gained life expectancy may not necessarily be years of bad health. Of course, this scenario is based on past developments and neglects potential future health threats like the consequences of increasing obesity levels and rising cognitive impairments at older ages. Nevertheless, fears of productivity losses may be partially absorbed by the improvements in individual health and education.

A smaller and older population may not only be more productive than expected but even cause less environmental pollution. When we observe individual consumption patterns and their ecological consequences, we find that over the life course younger individuals travel and consume more and, thus, cause higher CO2 emissions than individuals at retirement age. This implies that if today’s consumption behavior prevails, older and smaller populations may generate substantial CO2 reductions. We found that the change in population size and consumption preferences led to a 30% increase in emissions between 1950 and 2020. In the following decades, emissions could decline even to pre-1950s levels.

Apart from the challenges and opportunities on the population level, demographic change will certainly influence our individual lives and our family relationships. On average, we will live longer in good health and need care later, but there will be fewer younger individuals in our family network to support their elderly parents or other relatives. Whether changes in time use can make up for these missing individuals is questionable. We find that if the current work and leisure patterns prevail, individuals will spend slightly more time on leisure and housework and the share of work time drops from 14.5% to 11.9%. Whether the young really spend the additional time they have with the elderly remains to be seen. One important question in this respect is also how valuable the elderly will be in terms of resources they can provide. The wealth they pass on to the next generation will have to be shared with a smaller number of siblings and thus younger family members might be better off.

Certainly this study does not solve the challenges we face in the future, but it sheds some light on potential opportunities that aging populations create. During the coming decades societal frameworks will change and individuals will adapt their behavior to new expectations. The magnitude of the future effects is thus unknown, but we should start to discuss this potential, and favorable adaptations in our society. The future is not too bright, but also not as dark as sometimes argued and we do have the potential to change it.

Useful links

Ageing (Un)equally? OECD Forum 2014

Working better with age OECD review of policies to improve labour market prospects for older workers

OECD health data

Productivity and development: Competitive services can help, but can’t do everything

Cover-PGD_2014To mark the start of OECD Development Week, today we’re publishing an article by Martin Wermelinger of the OECD Development Centre

Strong growth over much of the past decade, particularly in China, has substantially boosted developing countries’ share of the global economy. In 2010, the share of global GDP of non-OECD countries overtook that of OECD countries, when measured in terms of purchasing power parity. But will this process of “shifting wealth” allow these countries to eventually converge with advanced country per capita incomes?

The 2014 edition of OECD Development Centre’s Perspectives on Global Development shows that, at their average growth rates over 2000-12, several middle-income countries will fail to reach the average OECD income level by 2050.Their challenge is deepened by the slowdown in China, where rapid growth has up to now benefited its suppliers, in particular natural-resource exporters. Boosting productivity growth will be the key for middle-income countries to stem this trend and help them sustain the transition towards high income levels.

During the transition away from being a low-income economy, productivity is boosted by shifting labour from lower to higher productivity sectors. This shift can continue to be an important factor even in middle-income countries, for example India and Indonesia. But once this process slows down, the focus needs to turn increasingly to productivity gains within sectors. This shift is evident in overall productivity growth in OECD countries. It is also evident in China, which has raised productivity in many manufacturing industries by tapping global knowledge through foreign direct investment and by importing capital goods and components.

For sustained convergence, productivity growth needs to accelerate. Over the past decade, productivity growth made only a marginal contribution to economic growth in many middle-income countries. The report shows that it was also insufficient to significantly reduce the very large gap in productivity with advanced countries. In Brazil, Mexico and Turkey, the gap even widened. By contrast, China recorded impressive growth in productivity: around 10% annually in labour productivity in manufacturing and services. Nonetheless, China’s labour productivity remains below one tenth of the levels of the United States.

Productivity slowdowns in middle-income countries can be associated with difficulties to move up the value chain, away from a low labour cost-driven to an innovation-driven growth path. The report argues that countries need to make greater efforts to diversify their economic structure towards higher value activities. To do this they have to increase the levels of educational attainment and skills of their labour force and improve their capability to innovate – to produce goods and services that are new to the economy. They can do the latter by importing new ways of producing and distributing goods and services, as well as by developing their own which can better suit their specific conditions or give them a competitive edge in the international market. There are also opportunities to boost growth and productivity in the economy by advancing better regulation and competition policies, improving capital and labour markets, and facilitating a more effective integration into global value chains.

The report devotes special attention to the services sector that has great potential to boost overall productivity and so support middle-income countries to converge to advanced-country income levels. First, rapid progress in ICT has allowed economies of scale in the production of most services and spillover effects to be realised. For example, countries where manufacturing sectors use outsourced business services are shown to be more productive. Second, the ICT revolution means that services can now be traded across borders, with India being the classic success example of this. And finally, as poor workers swell the ranks of a growing middle-class society, consumption of and demand for variety in products and particularly services will increase. Thus, identifying the emerging demands of domestic consumers and producing the goods and services to meet those new demands can boost growth in middle-income countries.

In fact, services contributed more than half of overall growth over much of the last decade in the BRIICS. Nonetheless, bypassing industrialisation and focusing directly on boosting services is not – or not yet – a proven success strategy for upgrading to middle-income, let alone to high-income, status. Even small, rich service economies like Singapore first industrialised comprehensively.

Although not exclusively, services can also help create jobs and – with their relatively low resource intensity – drive inclusive, sustainable development. Ultimately, however, the most effective combination of policies to reach the target of convergence through inclusive and sustainable growth will depend on the specifics of each country and, importantly, the capability of its governments not only to develop but also to implement their strategies. Governments need to obtain support for necessary reforms through consultation processes where key stakeholders – including private businesses, local communities and civil society – can voice their opinion and help formulate and implement strategies.

Useful links

Global Forum on Development

International Economic Forum on Latin American and the Caribbean

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