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KEY POINTS OF QUERY

What is productivity growth and how is it measured? Why is productivity growth that important? Why have some argued that productivity growth is bad as it results in rising unemployment? Why then do some economists urge the way forward for greater productivity growth? What are the costs of pursuing higher productivity growth?

There are some structural issues with our economy where a lot of businesses have learned to become much more efficient with a lot fewer workers. You see it when you go to a bank and you use an ATM, you don’t go to a bank teller, or you go to the airport, and you’re using a kiosk instead of checking in at the gate’. Those were the exact words of US President Barack Obama when asked about the high unemployment rates of 2011. Can this be true? Has high productivity growth really created unemployment? On paper, this sounds plausible. Automation and machinery have rendered certain jobs obsolete, and without the sufficient occupational mobility, structural unemployment will definitely take root. But should this be true? Wouldn’t it contradict Singapore’s productivity-driven approach to economic growth and higher wages, as reinforced by Prime Minister Lee Hsien Loong’s May Day speech this year?

To understand the dilemma between unemployment and productivity, we’ll first look at what exactly productivity is. Some jobs being rendered obsolete makes unemployment rise due to fall in demand for workers. Hence unemployment is demand deficient in nature.

Most of these productivity gains mean the rise of new industries where new skills will be required and given that workers are not equipped with the new skills, the structural unemployment that arises out of a mismatch of skills becomes the problem instead.

WHAT IS PRODUCTIVITY?

In economic terms, productivity is simply the value of output produced by one unit of input, such as how many cars a mechanic can fix in a day or how many

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plates of chicken rice the Hawker Center auntie can whip up in an afternoon. What we’re more interested in, however, is productivity growth. Productivity growth is a form of ‘intensive’ economic growth—getting more output with the same amount of input. Improvements in capital productivity (or the Marginal Product of Capital) arise from technological advancements that make machinery and computers more efficient, while improvements in labour productivity (or the Marginal Product of Labour) arise from better training, further education, and even the introduction of machinery to complement the jobscope of workers. Together, these two factors combine to give the overall productivity growth. Diagrammatically, this is represented by an outward shift of the PPC as seen in Figure 1 and an improvement in the Overall productivity growth, since the production of goods and services arises from a combination of several factors, together with labour and capital goods.

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The concept of marginal product refers to the output produced from employing one more unit of factor, be it labour or capital goods. For the current A level syllabus, knowing this term is not required, but understanding the concept will be helpful.

productive capacity of the country or an outward shift in the Long Run Aggregate Supply. From this, we can see that productivity growth is perhaps the only way for developed countries to sustain their economic growth patterns. After a country reaches full employment, there is simple no way to continue growing through ‘extensive’ means such as increasing the inputs of raw materials or increasing labour. Instead, the country has to rely on technological change to allow for the current set of resources to continually produce more output in the future. Does that mean that growth of developing countries will slow once they attain the developed status? Yes, but this is a natural phenomenon that has been observed throughout the last 200 years

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Why developed countries in particular? Since developed countries often tend to be operating at or near full employment, they face a problem of constraint of resources to support further increases in GDP without triggering inflation. Of course, some developed countries currently facing recessions do not face this problem in terms of lack of resources, but of the productivity growth needed to spur competitiveness and to get the economy growing again due to a previous lack of competitiveness.

This refers to growth attained by using more and more resources, such as increasing the population size of a country.

of economic growth, and is one of the reasons why many people expect the growth rate of countries like China to eventually slow down.

TFP: AN INDEX OF IGNORANCE

How do we measure productivity? Many of us have encountered the indicator, Total


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Factor Productivity, or TFP, but in reality this is an indirect measure of productivity. Though the terms TFP and Solow Residual are mentioned, these are not required in the A level syllabus for economics.

TFP measures the Solow Residual, named after economist Robert Solow, which is the unexplained portion of economic growth. In simplistic terms, to calculate productivity growth, you take a country’s growth in national income (GDP Growth) and subtract the growth in output due to an increase in the labour force and the increase in capital stock, and whatever discrepancy is left is the Solow Residual. Hence, TFP is often nicknamed as an index of ignorance, measuring the part of economic growth that economists can’t empirically predict. TFP thus measures the part of growth that is unaccounted for by the increase in inputs—in other words, the part of growth that arises from better use of existing inputs. Looking at TFP statistics over the last decade, you will realize that despite the

CAN PRODUCTIVITY INCREASE EMPLOYMENT?

Can productivity increase employment? We are almost certain the answer is yes. Economic growth in the past two centuries

Remember our earlier story of how productivity growth is reducing employment?

has been driven by massive gains in productivity, be it from the invention of the steam engine to the development of ICT, but the fact that economic growth has remained strong and unemployment figures have not skyrocketed through the roof shows that productivity growth has to be a good thing, and it is. Here are three examples.

and irrigation, freed up excess labour that eventually provided a supply of workers to feed the growing demands of the Industrial Revolution. In fact, almost every developed country has gone through this transition, with productivity growth in agriculture allowing for the transition from agriculture into industry, and productivity gains in manufacturing have resulted in a second stage of transition, from manufacturing into services.

2. Improvements in quality

Second, productivity growth is not limited to producing more units per given set of inputs, but also the production of higher quality output with a given set of inputs. As such, the absolute quantity of output may not have increased, but the quality of products has gone up. This will 1. Productivity growth in turn generate a higher demand for the stimulates demand good or service and will thus increase First, productivity growth lowers the employment as they hire more workers to costs of production, which translates to increase output. Just think of Apple’s new falling prices for consumers. Just compare range of MacBooks, recently launched at the prices of electronics and other WWDC 2012. Technological advancements manufacturing goods over the last twenty have allowed Apple to produce laptops years and it is clear how productivity at lower prices, but part of the innovation improvements have dampened prices. has been to raise the level of technology integrated into their products, be it a thinner When first introduced, prices FIGURE 1 Effects of productivity growth on an economy MacBook body or a higher of the latest LCD TVs cost an resolution Retina display. arm and a leg. Now prices I’m pretty sure Apple have tumbled, making them more didn’t lay off employees affordable and allowing households to have several LCD TVs in the home. because of their new breakthroughs. Consumers now have additional income, which 3. Market with an price elastic they can invest or spend demand on other goods, which Finally, the classic argument of stimulates consumption productivity raising unemployment often and demand. An outward runs along the lines of a firm having an shift of aggregate excess of workers as fewer workers are demand results and the required to produce the same output. economy experiences an But what if there is a demand for more increase in output and goods? If a production firm is running employment. The original at maximum capacity but still unable to industry where the satiate consumer demand, improvements efforts of the Singapore government, productivity growth took place may incur in productivity will allow that firm to TFP growth has averaged around 1% per unemployment, but jobs are created for Using less labour in annum, significantly below the OECD these workers in new industries spurred agriculture sectors has average. This is a surprising statistic to by the additional consumption due to allowed more workers to many, and perhaps a genuine cause for lower prices. be channeled into manufacturing chains concern. We will return to this surprising This is one of the key historical requiring large amounts of labour. Supply issue at the end of the article when we preconditions of economic takeoff that led of labour could then respond to demand look at productivity in Singapore, but first to the Industrial Revolution and economic patterns to allow for economic growth to let us return to the issue of productivity growth. Improvements in agricultural occur. and unemployment. productivity, such as the use of fertilizers THE UNEMPLOYMENT ISSUE

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CAPITAL PRODUCTIVITY GROWTH, HOWEVER, HAS CREATED NEGATIVE IMPACTS ON THE LOWER-INCOME GROUP DUE TO THE INCREASING SUBSTITUTABILITY OF LOW-SKILLED WORKERS WITH CHEAPER, MORE EFFICIENT, MACHINERY.”

expand output to the required quantity. In this case, the firm would want to expand and the jobs of workers would be safe.

SO WHAT IS OBAMA SAYING?

From the three arguments above, it is evident that productivity growth has a slew of positive benefits and has been an integral part of economic growth and development. Why then does Obama still believe that ATMs and automated kiosks are the bane of employment? The reason is not that Obama is misinformed, but rather that he has focused on a smaller subset of workers: low-skilled, low-income workers. Much of the productivity developments of the past decade have been biased towards highskilled workers, and they have been the Productivity growth has created higher demand for highly skilled workers while displacing or lowering the demand for low-skilled workers. By emphasizing the negative aspects of productivity gains, the focus is placed on low-skilled workers. Hence, a more accurate picture of productivity growth is that there are gainers and losers, and the overall effect of productivity growth needs to be weighed out.

ones benefitting from productivity growth. Capital productivity growth, however, has created negative impacts on the lowerincome group due to the increasing substitutability of low-skilled workers with cheaper, more efficient, machinery. Therein lies the major problem. Improvements in capital productivity have led to technologies and innovations that complement the jobs of high-skilled workers. Faster computers, better software, and high-tech tools still require human operators and aid in improving

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the productivity of the high-skilled labour pool. Hence, they reap the majority of the benefits of productivity growth. However, the story is different for the low-skill workers, where technology developments have led to the development of machinery that substitutes for low-skilled labour. The ability to use cheaper machinery to replace low-skilled workers lowers the cost of a service or good and perhaps creates employment elsewhere, but the fact remains that many of these unskilled workers don’t have the required skill set to transition into new job opportunities. Many of the current jobs held by unskilled workers also don’t face a price elastic demand market. There are only so many bank outlets required on the small This means that in such industries, it is not the case that wages fall and there will be a sudden surge in quantity demanded of low-skilled workers (movement along with demand for labour).

island of Singapore and improvements in banking technology like ATMs will inevitably lead to unemployment as there is simply no need to further expand banking services on the island. Not only does this lead to unemployment, but it also lowers the real wages of the remaining unskilled workers, as they now face stiffer competition from the cheaper machinery. Technological improvements have lowered the price of automation. When the price of machines remains high, firms are resistant to automation and employment of low-skilled workers remains high.

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INCOME INEQUALITY, NOT UNEMPLOYMENT

Putting everything together, we see that this is not a problem of productivity and employment but a problem of the biased distribution of the costs and benefits of productivity growth. Unemployment and lower wages of the lower skilled section of the workforce, combined with higher employment in the higher skilled section, leads to an incidence of growing income inequality. That is the problem caused by productivity growth, and that is the problem governments are trying to solve. Productivity growth creating unemployment is not a long-term problem. It is only a problem of transition, as long as governments put effective supply side policies in place to retool the skills of workers. The more qualified problem of productivity growth may instead be the rearing head of rising income inequality we hear of these days.

Now that we have established the link between employment and productivity, let us turn our eyes back to Singapore and Singapore’s dismal TFP statistic.

THE PRODUCTIVITY PROBLEM IN SINGAPORE

At the peak of growth of the East Asian Tigers, Hong Kong, Singapore, South Korea, and Taiwan were averaging economic growth rates of more than 6% per annum. However, in 1994, Alwyn Young published a revolutionary paper that showed that these extraordinary growth rates were a result of factor accumulation and not productivity. Titled The Tyranny of This means that these economies were able to show high growth rates based on accumulating more resources rather than using these resources more effectively. The growth was through ‘extensive’ rather than ‘intensive’ means.

Numbers, Young showed how the East Asian growth miracle was fundamentally based on rising participation rates, one-off improvements in education levels, and capital accumulation through investment, and not productivity. Some fifteen years later, Singapore is still plagued by the same problem. Productivity growth has averaged just 1%


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in the last decade, with our productivity in manufacturing being 55% to 65% of that in the US and Japan. Productivity in the construction sector is even worse, at about 34% of Japan’s productivity levels. In fact, Singapore even had a stunning -14% TFP decline in 2009, when the world average was at about -1%. The ironic thing is that it was in the midst of clocking a 10% growth in GDP in the first quarter of 2012. How is this possible?

THE CATCH-UP HYPOTHESIS

Looking through economic history trends, Singapore has always been more of the exception than the norm. Often, developing countries clock significantly higher growth rates of TFP in the early stages of development before slowing down towards the world average after achieving developed status. This convergence process between the developing and developed country is dubbed the Catch-Up Hypothesis, advocated by economists such as Williamson and Abramovitz. The idea is simple: The larger the productivity gap between the country and the leading economies, the faster the productivity growth. This hinges on technological transfer as knowledge flows from the leader countries to the converging countries, allowing catch-up countries to imitate the best technology available without incurring the fixed costs of innovation. After the country has managed to catch up, however, productivity growth slows as it has to spend funds on innovation and research to push technology frontier. Many countries in the past have followed this developmental pathway, such as Continental Europe during the golden age of 1950–73, Japan during the 1970s and ‘80s, and more recently, China. China has had remarkable TFP growth, accounting for over 50 % of its extraordinary growth rate, attributed to the introduction of market incentives in the socialist state, as well as an abnormally high rate of investment. Of course, there are exceptions as well. The Soviet Union based its catch-up growth primarily on increased labour force participation and increasing inputs of raw materials, which was one of the economic reasons behind the Soviet Union’s economic collapse. It simply ran out of new people or new resources to inject into the economy.

Without productivity growth, economic growth simply stopped. Where does Singapore fit in? As shown previously, our TFP growth rates have been dismal at almost every stage of our developmental pathway, so the standard Catch-Up Hypothesis doesn’t hold up. Much of Singapore’s high growth rate is thus attributed to other factors, such as longer working hours, with Singapore’s average of 2,307 hours per annum being the highest in East Asia. Our high inflation rates, reaching 5.4% in April, are also a result of this, with continuously rising aggregate demand lacking a corresponding rise in aggregate supply and productivity, leading to demandpull inflation. It can thus be argued that Singapore’s growth rate was more internally driven rather than a result of technology flow from leader countries. Closer analysis by the Economist Division at the Ministry and Trade and Industry revealed that capital productivity in Singapore is actually growing at a respectable rate, but labour productivity has been stagnant. The reason? A lax foreign labour policy that provides a large pool of foreign unskilled workers. The direct consequence of this is that it is cheaper for firms to hire cheap foreign workers to do a job without any incentive to improve human capital or to develop labour-saving technologies.

LOOKING AHEAD

It is thus of no surprise that the government has embarked on numerous initiatives in a bid to raise human capital standards. Baby steps taken in tightening the foreign labour policy during rising foreign worker levies have caused local and foreign firms based here to start feeling the pinch of hiring cheap foreign workers, and to perhaps kick-start the process towards greater productivity growth. Others have taken a step further. In a shocking proposal in April 2012, Professor Lim Chong Yah of the Economist Society suggested a ‘wage shock’ to force productivity growth. In his proposal, the wages of workers earning S$1,500 and below would be increased by 50% over the next three years while a salary freeze for those earning more than S$15,000 a month would be implemented in tandem. For the middle income, he proposed pay increases between a quarter to a third of those received by the lowest income group.

Such a move would force local firms to match the 50 % rise in wages with a 50% rise in productivity in order to stay afloat. A risky gamble, no doubt, but it shows the desperation of the Singapore economy to generate productivity improvements to sustain our extraordinary growth rate. Will Singapore’s miraculous growth rate continue? Whether this question will receive a positive or negative answer hangs on our ability to kick-start productivity growth within the next decade, which will require cooperation of both the government and the people. As future entrants into the workforce, perhaps it is time for us to take our education a little more seriously and to spend this precious time to upgrade ourselves to the fullest. Then the prospects for Singapore will be a little greener. REFERENCES Abramovitz, M. (1986). Catchin Up, Forging Ahead, and Falling Behind. The Journal of Economic History , 46 (2). Ning, T. S. (2012, April 10). The Business Times. Retrieved June 2012, from Local economist suggests second wage revolution: http://www.asiaone.com/ Business/News/Story/A1Story20120410-338821.html Young, A. (1994). The Tyranny of Numbers: Confronting the Statistical Realities of the East Asian Growth Experience. NEBR. Sim, F. (2012, April 30). Yahoo News. Retrieved June 2012, from Raise productivity to raise wages: PM Lee: http://sg.news.yahoo.com/raise-productivity-to-raisewages--pm-lee.html Wijaya, M. (2010, March 23). Asia Times. Retrieved June 2012, from In Singapore, productivity at all costs : http:// www.atimes.com/atimes/Southeast_Asia/LC23Ae01.html Teo, A. (2010, Jan 31). The Business Times. Retrieved June 2012, from Singapore sweats away the hours - and productivity: http://www.asiaone.com/Business/News/ My+Money/Story/A1Story20100129-195280.html Spring Singapore. (2012, March 9). The Business Times. Retrieved June 2012, from ‘Missing’ points in Singapore’s productivity policy identified: http://www.spring.gov.sg/ NewsEvents/ITN/Pages/Missing-points-in-Singaporesproductivity-policy-identified-20120309.aspx Schuman, M. (2011, February 23). Time.com. Retrieved June 2012, from Does better productivity kill jobs?: http:// business.time.com/2011/02/23/does-better-productivitykill-jobs/ The Straits Times. (2010, Februrary 1). The Straits Times. Retrieved June 2012, from Singapore’s Productivity Problem: http://www.straitstimes.com/STI/ STIMEDIA/pdf/20100201/020110productivity02.pdf Fox Nation. (2011, June 14). Fox Nation. Retrieved June 2012, from Obama Blames ATMs for High Unemployment: http://nation.foxnews.com/presidentobama/2011/06/14/obama-blames-atms-highunemployment Yglesias, M. (2011, June 20). Think Progress. Retrieved June 2012, from Does President Obama Believe Productivity Growth Explains High Levels Of Unemployment?: http://thinkprogress.org/ yglesias/2011/09/20/323488/does-president-obamabelieve-productivity-growth-explains-high-levels-ofunemployment/ Indiviglio, D. (2009, November 5). The Atlantic. Retrieved June 2012, from What Does Productivity Mean For Unemployment?: http://www.theatlantic.com/ business/archive/2009/11/what-does-productivity-meanfor-unemployment/29672/ Tabarrok, A. (2003, December 31). Marginal Revolution. Retrieved June 2012, from Productivity and Unemployment: http://marginalrevolution.com/ marginalrevolution/2003/12/productivity_an.html

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FA_p32-37 Vol4-4 Productivity and unemployment