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What's Draining Productivity? - Part II - Outside View by Nitin Gregory

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What's Draining Productivity? - Part II
May 16, 2017

Productivity increases are a key driver of growth. In developed economies, capitalism has channeled 'risk-seeking' behaviour to generate productivity and growth. This has resulted in better living standards (with some big missteps along the way). Market and government failures have resulted in course corrections along the way. Nevertheless, this model has generated steady but relatively low growth over a century. But as Einstein famously said, 'Compound Interest is the eighth wonder of the world.'

I've written before that 'corruption' and 'speculation' drain productivity. Another phenomenon gaining traction of late is protectionism. According to David Ricardo's theory of comparative advantage, trade makes everybody better off. The benefits, however, can be quite unequal.

Branko Milanovic's 'elephant chart' from his 2012 policy research paper has become a popular visual to explain the unequal effects of globalisation. The richest 1% and the emerging markets' middle class have seen spectacular gains, while the developed markets' middle class (the world's 80th percentile) has been stagnant for more than two decades.

The discontent is manifesting itself in the rise of 'deglobalisation'. Characteristic of this trend is a nationalist economic agenda - that is, trade protectionism. For example, heavy tariffs proposed on imports and penalties on companies that outsource jobs to low-cost countries. The argument is that a more protective trade stance will help stem job losses from outsourcing and offshoring.

Trade and Productivity

Imports can actually increase productivity. Firms facing import competition have to invest in capital stock (like R&D, automation and other improvements), which results in productivity improvements. Diffusion of technology and know-how is another productivity booster resulting from trade. This is similar to the 'catch-up growth' we see in developing nations.

Another argument is that competition from imports will release resources from inefficient producers as they go bankrupt. This should help channel capital and labour into productivity-increasing pursuits.

For example, a developing country can produce a shoe at lower labour costs for export to a developed country. The resources in the developed country that would otherwise go to manufacturing that shoe are now free to produce something of higher value - like internet services or robots.

Thank You for the Shoe - Where Are My Jobs?

We have already discussed the tell-tale signs of deglobalisation. The anti-free trade outlook in US politics, Brexit, the non-ratification of TPP - the barriers to trade are becoming evident in developed countries. This is driven by a strong dissatisfaction in the electorate. Free trade, unrestricted imports, and labour movement are considered bad. And this has resulted in deep changes to the labour structure of developed economies.

At first glance, the logic is clear: If you stop imports and produce locally, this will create local jobs. Country A is a developing country with average wage levels of $X. Country B is a developed country with average wage levels at 10X. Country B needs to create ten times more shoes per person for the cost of shoes to remain constant. That leads us to the question: Will a robot replace me?

The jobs created will have to be heavily automated. In other words, to keep productivity high, technology will be key. Automation is a long-term trend that will affect all countries. There is an active debate on the impact of autonomy, artificial intelligence, and other exciting changes.

Climbing the Productivity Ladder

In theory, this is what should happen: Low productivity jobs move to low-cost labour locations. Developed economies climb the productivity ladder and produce high-end goods and services.

But increasing productivity is messy and risky. It requires entrepreneurs to try and fail. It also requires investment in human capital. Entrepreneurs might want to take a risk and invest in flying saucers - but who will engineer them? This means the workforce has to have a high skill level. This has previously been described as rising entry-barriers for the middle class

Protectionism is definitely a drain on productivity and growth. But the alternates look difficult. Is there a way for increased productivity to be profitable for all? We will explore that question next time...

This column is authored by Nitin Gregory. Nitin, who graduated from IIM-Calcutta, is currently pursuing a finance role with an automotive major. He has a deep interest in Macroeconomics and pens a blog at Gregonomics.

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