What We Talk About When We Talk About Productivity

I talk about how “we need higher productivity” a lot, so I should probably clarify what I mean by that.

Productivity is output divided by input. If you get more economic output with the same number of input labor hours, productivity has grown. Similarly, if you get the same amount of economic output from fewer worked hours, productivity has grown. And if you get the same amount of economic output from more worked hours, productivity has shrunk.

But here’s the thing. Worked hours is an aggregate figure. Individuals who work zero hours are not contributing any labor inputs, but they are still “on the books” as people who consume a portion of the national income. Rising unemployment and underemployment can appear to be increasing national productivity, but whether that’s truly the case depends on where these workers end up once the economic climate improves.

Compare two situations of countries entering recessions. As the first country enters recession, businesses begin to lay people off. Partly this is due to a need to reduce output in the face of lower demand, but partly it is due to pressure to maintain profits when sales are stagnant or falling; the only way to do that is to “do more with less” – i.e., increase productivity. So the business will lay off marginally productive employees and rationalize a variety of processes and wind up with a more productive workforce. Multiply this across the economy, and you wind up with a higher unemployment rate, and negative economic growth, but a sharp rise in labor productivity. This is what usually happens: when unemployment rises, productivity does as well.

Now let’s look at the second country. As it enters recession, it faces the same pressures. But it has strong laws and/or norms against layoffs. So businesses retain more workers than they really need. But sales and profits are still falling. So the businesses in this country cut costs by reducing the hours and/or wages of their employees rather than laying off marginal workers. In aggregate, because less-productive workers are retained, the businesses in this country will produce less output per labor input. Multiply this across the economy, and this second country will have a lower unemployment rate and lower labor productivity.

But is that “really” the case? Is the second country’s economy “really” less productive? A proper measure of productivity would account not only for the drag of retaining less-productive workers, but also the drag on the economy of having to support people who aren’t working at all. The productivity measure that makes perfect sense for an individual firm makes very little sense for the economy as a whole because you can’t lay people off from an entire economy. People who are completely unproductive – because they don’t generate any output at all – aren’t a drag on any individual business, but they are a drag on the economy as a whole.

The case for not following the second country’s path isn’t that in the depths of the recession their economy is less productive. In fact, the second country is probably doing better in the middle of the recession even though their productivity statistics look worse. The case is that once the economy recovers, the first country will retain its productivity gains, and the unemployed workers will be reabsorbed into the workforce in more productive roles than they would have had in the second country’s situation, and that this effect will overwhelm the drag associated with temporary unemployment. But that’s an empirical question that will be tested once the economy recovers. It’s not something that can simply be assumed.

Let’s take another illustrative example. Assume for the sake of argument that, on average, people over age 62 are less productive than people under age 62. Now suppose one country has a retirement age of 62 and another has a retirement age of 65. The first country should show higher labor productivity than the second, because it has created incentives for people to retire from the labor force earlier. But its economy as a whole should be less productive, because citizens in the first country who are aged 63 are producing nothing, while in the second country citizens aged 63 are contributing to the economy. In this case, there’s nothing temporary about the choice. We’re not talking about temporary unemployment and whether it makes the economy more or less productive over the longer term. We’re talking about permanently reducing the size of the labor force. That’ll make it appear more productive, but it’s actually reducing the productivity of the economy as a whole.

Of course, there are problems with any statement that so-and-so isn’t “contributing to the economy.” There’s a lot of (arguably) valuable work that is undertaken on a volunteer basis: raising children, organizing a softball league, (blogging). In the classic example, if two women each raise their own children, they are not contributing to GDP, but if they each pay each other $15/hour to provide each other with childcare services, suddenly they are contributing to GDP, even though no additional value has been created. Notwithstanding this objection, I think my point is still valid. Saying that productivity goes up in recessions is only “really” true if the gains are sustained through the period when the economy gets back to a comparable level of labor force participation. If the size of the potential workforce (able-bodied individuals of working age) is stable between two points in time, and total hours worked across the labor force is the same at each of those points, but output is higher at the second point than at the first, then we can say that labor productivity has increased. If, on the other hand, lots of people dropped out of the labor force between the two points – retired early, were sent to prison, stayed in school an extra year without acquiring useful skills, became discouraged workers – then the apparently higher productivity at the second point is at least partly an illusion. The economy isn’t actually more productive; we’ve just taken the least-productive people and made them completely unproductive.

So when I talk about “increasing productivity” I mean productivity properly measured: from peak to peak in terms of labor force participation. Right now, we show pretty decent productivity numbers, but I pay essentially no attention to that because they appear to be achieved by laying off marginal workers and not much else. If we don’t lay the groundwork for re-employing those workers more productively than they were employed before – whether because their skills atrophy and they drop out of the workforce permanently, or in the unlikely event that we decide to employ them in make-work jobs that are even less-productive than what they used to do – then the apparently decent productivity numbers will turn out to be entirely illusory.