Productivity growth – a key production concept

It’s hard to think of a more important method of measuring productive efficiency than productivity. Producing more by using fewer inputs is the key to understanding lean production. Productivity can also rise if firms make more, but hold inputs steady. Either way, boosting productivity is a crucial ingredient in business success. So what are the latest trends in productivity, and what are behind the changes?

A recent Economist article has covered this topic by comparing Europe to America in the recent recession. America has gone on a diet: its firms have squeezed extra output from a smaller workforce and suffered a big rise in unemployment as a consequence. Europe, meanwhile, is hoping to burn off the calories in the future. It has opted to contain job losses at the cost of lower productivity.

One piece of research shows just how different the recession was on either side of the Atlantic. America’s economy shrank by around 2.5% last year but hours worked fell at twice that rate, so productivity (GDP per hour) rose by 2.5%. The average drop in GDP in Europe was larger, at 4.2%. But hours worked fell less sharply than in America and, as a result, EU productivity fell by 1.1%.

1/ Were American firms were panicked into shedding jobs too quickly (though brutal cuts in capital spending suggest that Europeans were scarcely calmer)?

2/ Perhaps some of the productivity-growth gap is explained by different labour regulations. America’s more flexible jobs market makes it far easier and cheaper to lay off workers. In many parts of Europe, by contrast, firing workers is costly and unemployment benefits are generous. Firms think twice about firing, and governments are keener to provide in-work subsidies if it means avoiding payouts to the newly jobless. Unemployment has risen most where workers are easiest to offload, as in Ireland or Spain.

3/ In Europe the shock of recession is likely to persist for longer. Falling productivity pushes up unit-wage costs, hurting profits and cash-flow. Firms cannot bear that for ever. Long hiring freezes seem likely and some businesses will be forced into lay-offs.

4/ What happened in the last recession, just after the dot-com boom (and bust)? Though IT spending collapsed in 2000, firms were still finding new ways to apply the computing power they had invested in so heavily so productivity soared as the recession ended. It will be harder to repeat that trick this time.

Several trends point to slow long term productivity growth. What do you think will be the key areas in which firms will be able to boost their productivity over the next decade?