IGCE,Economic Growth - Productivity & Economic Development, A LEVEL Notes

Economic Growth - Productivity & Economic Development

Introduction

Productivity is a measure of the efficiency with which a country combines capital and labour to produce more with the same level of factor inputs. We commonly focus on labour productivity measured by output per person employed or output per person hour.

A better measure of productivity growth is total factor productivity which takes into account changes in the amount of capital to use and also changes in the size of the labour force.

If the size of the capital stock grows by 3% and the employed workforce expands by 2% and output (GDP) increases by 8%, then total factor productivity has increased by 3%.

Productivity is an important determinant of living standards – it quantifies how an economy uses the resources it has available, by relating the quantity of inputs to output. As the adage goes, productivity isn't everything, but in the long run it’s almost everything.
Higher productivity can lead to:

• Lower unit costs: These cost savings might be passed onto consumers in lower prices, encouraging higher demand, more output and an increase in employment.
• Improved competitiveness and trade performance: Productivity growth and lower unit costs are key determinants of the competitiveness of firms in global markets.
• Higher profits: Efficiency gains are a source of larger profits for companies which might be re-invested to support the long term growth of the business.
• Higher wages: Businesses can afford higher wages when their workers are more efficient.
• Economic growth: If an economy can raise the rate of growth of productivity then the trend growth of national output can pick up.
• Productivity improvements mean that labour can be released from one industry and be made available for another – for example, rising efficiency in farming will increase production yields and provide more food either to export or to supply a growing urban population.
• If the size of the economy is bigger, higher wages will boost consumption, generate more tax revenue to pay for public goods and perhaps give freedom for tax cuts on people and businesses.

The Productivity Gap

Productivity varies hugely across nations. The Millennium Development Goals Report for 2012 stated that the dollar value of output per worker in the developed regions of the world was $64,319 in 2011, compared with an average of $13,077 in developing regions.

A table of selected data on output per worker employed is shown below.

Output per worker  ($000, at constant 2005 prices, PPP adjusted)	1991	2011
Sub-Saharan Africa	5	6
Southern Asia	4	9
South-Eastern Asia	6	10
Latin America and the Caribbean	20	23
Developing regions	6	13
Developed regions	48	64

What are the main determinants of factor productivity in a country?

For example, South Korea has achieved sustained improvements in labour productivity – a key factor behind escaping the middle-income trap.

Our chart below tracks the annual change in output per worker employed and real GDP. Higher productivity growth is a key reason why South Korea has now become a high-income member of the OECD.

Case Study – Productivity Gains in China

China has achieved impressive gains in productivity in recent years. Some of this is undoubtedly the huge spending on capital investment which has grown to nearly 50% of China’s GDP. The labour force has also grown although this is scheduled to level off and then decline in the years ahead.

What has driven improvements in Chinese total factor productivity?

• Resource shifts: There has been a huge shift of resources out of relatively low productivity agriculture into more productive work in manufacturing industry and construction. Over half of the Chinese population now lives in urban areas.
• New technology and innovation: The willingness of Chinese businesses to adopt and exploit new production technologies and process innovations. Mobile telephony has expanded at a rapid rate
• FDI effects: High levels of foreign direct investment into China have boosted productivity – new manufacturing capacity and technology has lifted efficiency and may well have led to productivity spill-over effects among supply-chain businesses. For example, in April 2012, Samsung Electronics, the world’s biggest memory chip maker, unveiled plans to invest $7bn (£4.4bn) to build its first chip factory in China.
• Openness and global competition: The Chinese economy has become more open – trade is accounting for a rising share of national income – global competition is a stimulus for efficiency improvements
• Better infrastructure: Heavy state spending on critical infrastructure has improved the overall efficiency of the economy for example in reducing transport delays and increasing communication speeds
• Management: Restructuring of state-owned businesses has been a factor behind better productivity. The Economist magazine reported recently that “sophisticated methods of control, more productive use of assets and rapid globalisation have boosted productivity”
• Improved wages: There is strong pressure for mean wages to rise in China especially as the latest Five Year Plan emphasises the need to boost domestic demand. Will a number of years of rapid wage acceleration provide a boost to worker productivity?

Although China’s productivity improvements are impressive, the process of catch-up with advanced nations still has a long way to go. China’s labour productivity is about 12 per cent of that of the USA

Case study: Improving Productivity in Agriculture – Focus on the Indian Farm Sector

Some of the gains from rising farm productivity are expressed in the flow chart below. For India, despite attempts at land reform to boost the incentives for farmers, agricultural value added per worker expressed in real US dollars has grown slowly. The divergence between India and South Korea is striking.

The virtuous circle of rising agricultural productivity

In 2011, nearly 70% of Indians still live in the countryside and over half work on the farm but many are tenant farmers operating with short-term leases on their land and with little incentive to invest in machinery to improve farm yields and incomes. For example, annual rice yields in the Indian state of West Bengal remain at about half China’s level and below yields in Indonesia, Taiwan and Vietnam. Productivity is further hampered by inadequate infrastructure including poor roads and vulnerability to external climatic shocks such as droughts and floods.

Critics of India agriculture argue that whereas China has liberalized farming markets and encouraged farmers to build up surpluses to sell in local and regional markets, the India government spends too much money subsidizing fertilizer, power and water and price supports for certain farmers that have done little to stimulate diversification among rural producers.