The productivity and inequality nexus; is there a benefit to address them together?

By Gabriela Ramos, Special Counsellor to the OECD Secretary-General, Chief of Staff and Sherpa

The story of the last eight years has been one of policy makers around the globe doing all they can to avoid a worsening of the impact of the financial and economic crisis of 2008, and to boost growth. It has also been one of addressing key challenges as they emerge. As Chief of Staff and Sherpa, I have been privileged to be part of the global conversations to find the solutions to these challenges, both at the G20 where I represent the Secretary General, and at the OECD.

We are not yet out of the woods. On the contrary, we face the tween challenges to overcome a new wave of instability in the financial markets and the significant downturn of emerging economies, paired with the more structural challenge of a slowdown of productivity growth and increased inequalities of income and opportunities all across the OECD and the G20 members. All these is weighing heavily on living standards and getting in the way of better economic performance.

On the productivity front, the pre-crisis period saw the trajectory of global labour productivity growth accelerate from 1990, as a pick-up in in emerging market economies more than offset a slowdown in advanced economies.  Post-crisis it has been a different story, with growth in multi-factor productivity (MFP) and labour productivity relatively weak across the board.[i] Labour productivity growth provides a compelling example. In the wake of the crisis, between 2007 and 2013 labour productivity[1] grew at an annual rate of just 0.71% on average across the OECD. That is compared with a growth rate of 1.82% prior to the crisis between 2001 and 2007.[ii]

But this is not the whole picture. Scratch beneath the surface and the image is less homogeneous. Recent OECD work on the Future of Productivity shows that there has been a marked divergence in productivity growth rates between those firms operating at the global frontier –at around 3.5%- and those lagging further behind –at 0.5%-, reflecting a slowdown in the diffusion of knowledge, or a breakdown of the diffusion machine, as we call it.

On the other hand, inequalities of income and opportunities are unacceptably high. In OECD countries the top 10% now earn 9.6 times the income of the bottom 10%.[iii] In terms of wealth the situation is markedly worse, with the top 10% owning more than half of total household wealth in the majority of OECD countries.[iv] But inequalities are not just a question of wealth and income. The OECD’s work on Inclusive Growth has highlighted the multidimensional nature of inequalities, with low income groups having lower access to quality education or quality health services, perpetuating a vicious circle of exclusion and lower intergenerational mobility. Consider education, in the OECD area adults aged 25-64 with tertiary education have lower unemployment rates than their counterparts, are more likely to be in the labour force in the first place, earn higher salaries, and enjoy good health. They are even more likely to live longer.[v]

This is neither fair on those left behind nor economically efficient!

The linkages between the productivity and inequality challenges remain to be fully explored, and each may have its own independent solution. But there is good reason to think that there is a nexus among them. For instance, preliminary evidence from the OECD 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 may have led, in some instances, to an increase in rent seeking behaviour. In addition, OECD research has highlighted how high inequality has become a brake on GDP growth, as 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.

Moreover, 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 operate in low productive, precarious jobs or – in many emerging countries – in informal jobs.

Following in the footsteps of our integrated framework on inclusive growth, and the call that our NAEC initiative makes to think about the synergies and trade-offs between different policy areas, our efforts to address the productivity and inequality challenges could have a better chance of succeeding if we look at these policies’ synergies and trade-offs. At the very least, we need to ensure that we test policies to address each issue whilst also bearing in mind its impact in the second domain. We need to avoid the “silo” approach, to develop more effective and comprehensive policy packages.

And we must learn from previous policies. Traditional measures to boost productivity in the 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 impact on inequalities of income and opportunities, as workers better fitted to cope with change are usually those with higher set of skills.

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, as recent Job quality work of the OECD highlights, where low skilled individuals are trapped in precarious low wage jobs, and receive less training.

Ricardo Hausmann, the Harvard economist, makes exactly that point when he notes that the main inequality across countries is inequality of productivity. He argues that it is hard to put in place the conditions for high productivity (i.e. high human capital, good quality infrastructure, access to financing) universally and that it is much easier for governments to focus on a traditional approach which promotes these conditions in a few regions, a few firms and amongst a few people. The up-shot of this is clear: poor people are being left out of high productivity activities, for want of access to opportunities.

Much work remains to be done to gather evidence about the interaction between productivity and inequality, but there is no doubt a need to do so, to ensure better policies. This is precisely what the OECD is doing. Indeed, we need to focus on how to ensure that individuals, firms and regions that are left behind can fulfil their full potential and contribute to a more dynamic economy.

Our approach draws on cutting edge OECD work from diverse policy areas. It starts from the OECD’s Inclusive Growth agenda, by focussing on well-being as an ultimate objective of policy. It builds on ground breaking OECD productivity work via the Future of Productivity report and the efforts Towards an OECD Productivity Network. Finally, it also synchronises with the Organisation’s on ongoing efforts to measure productivity more accurately – at a time when our traditional measures are ill-adapted to account for the full effects of rapid technological change and innovation based on knowledge base 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 and support productivity growth simultaneously, thereby creating a virtuous cycle for inclusive and sustainable growth. This could include an ex-ante and ex-post assessment of policies and outcomes, and 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 individual circumstances, and it is true that we still need to gather more evidence and analysis on the nexus between productivity and inclusiveness. 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, to allow for the mobility of workers and inclusion of underrepresented groups such as women and youth, and to 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 a normal phenomenon, the widening dispersion we observe and the implications it has on 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.[vi] The gap was even more pronounced in the services sector. The larger the share of business that can thrive the more productive and inclusive will our economies 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 often 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 promote synergies and deal 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. Our productivity and inequality challenges are not insurmountable. It is time we took a comprehensive approach to Inclusiveness and productivity to overcome them.

[1] GDP per hour worked, total economy – percentage change at annual rate.

[i]                  OECD (2015), Future of Productivity, OECD Publishing Paris.

[ii]                  OECD (2015), Compendium of Productivity Indicators, OECD Publishing Paris.

[iii]                 OECD Income distribution database: http://www.oecd.org/social/income-distribution-database.htm

[iv]                 OECD (2015), In it Together, OECD Publishing Paris.

[v]                  OECD (2013), Health at a Glance 2013: OECD Indicators, OECD Publishing Paris.

[vi]                 OECD (2015), Future of Productivity, OECD Publishing Paris.