Productivity Puzzle

Everyone Assumed That Productivity Growth Would Increase with the Employments Contracts Act. But Check the Data: No Significant Change.

Listener: 27 July, 1996.

Keywords: Growth & Innovation; Labour Studies;

The non-ideological economist would have made three confident predictions about the effects of the Employment Contracts Act (ECA) introduced in May 1991. First, it would weaken the unions. True. Second, it would depress wages of low pay workers (because of the mass of unemployed with similar skills). True. Third, it would generate productivity increases (at least in the short term). False.

How can it be false? Everybody says there have been productivity gains from the ECA. Ruth Richardson said so in her book; Wolfgang Kasper said so in his book (Free to Work); the Business Roundtablers say it; the Employers Federation say it; even a survey had employers saying it. But note that none of them report measures of productivity. They all rely on anecdote (sigh).

Since March year 1991, average labour productivity (measured by output per worker) has risen by just 2.5 percent in five years, or .5 percent a year. But can we attribute the productivity rise to the ECA? In the previous five years, productivity had risen 4.0 percent or .8 percent a year. Thus productivity seems to have grown more slowly since the ECA than before it. I have said “seems” because the data is subject to error. What however is undeniable is there has been no significant increase in productivity growth since the ECA was enacted in May 1991.

I am astonished too. I keep going back and checking the numbers, fiddling with definitions. But the same general result always comes out: no significant change in the productivity trend. Coming to think about it, recall all the excitement about the ability of the New Zealand economy to generate jobs in recent years. Economic growth has been modest, so the job creation has occurred because of the small gains in productivity. If we had had the Australian productivity growth record, we would have had lower employment growth, and higher unemployment. Those who praise the improvement in out labour market cannot also praise our productivity growth (unless they do not know what they are talking about).

What I had assumed – what everyone had assumed – was workers had imposed work practices in the old industrial relations system which reduced output. There are anecdotes to support this, and the generalization seemed safe. Since the ECA would give mangers greater power to manage, it seemed likely they would use this power to eliminate these inefficient work practices, generating higher productivity. Again there are anecdotes. But, apparently, insufficient to affect overall productivity significantly.

Perhaps insofar there were worker controlled work practices they did not affect productivity. On reflection that it is not so surprising. Workers have an interest in higher productivity because they can extract higher pay. Perhaps there were only few occasions when they restricted efficiency in a way that reduced their pay. That is the best hypothesis that I can offer. If it is true, the gains to employers from the ECA have been lower pay and greater freedom to manage, not in higher output per worker.

Moreover there is another puzzle for which I have even less of an explanation. Look at the productivity growth over the last decade, averaging just over .6 percent a year. For most of the post-war era the rule of thumb was that labour productivity grew at just under 1.5 percent a year (even under Muldoon). For the last ten years it has grown at half that. Why? It would be easy to say it was a measurement problem, but nobody has actually found the defects in the data. Another possibility is a change in the structure of production, but nobody can explain how such a change would halve of the productivity growth rate.

Many people will say this is all a result of Rogernomics. I use to think so too. Economic stagnation would tend to discourage innovation, investment, and expansion. That would appear as poorer productivity growth. I am still inclined to think this the best explanation, but the low growth rate has been so persistent (even in the upswing of a couple of years ago), that I am beginning to wonder if something else is going on – or going on as well.

There is a body of economic literature which suggests that some time in the mid 1970s the productivity growth rate for most OECD countries slowed down. The technical term for this is “climacteric”. There is considerable dispute as to why the climacteric happened, which is not surprising given that it requires decades of solid data to untangle what is happening to long term growth rates.

New Zealand’s productivity growth rate seemed to continue on the pre 1970s trend until the mid 1980s. (Nobody knows why.) But now like the rest of the OECD we seem to have gone through a climacteric too – a decade later.

You may be surprised that economists – some economists anyway – occasionally admit that there are things we do not know. Others will assure you that there will soon be substantial productivity gains, because the right policies have been put in place. They have been promising that for ten years.