### Productivity and Employment: A Cautionary Tale

Ah, productivity. Who knew that our whole prosperity was totally dependent on a concept as nebulous as this?

To be sure, it doesn't sound nebulous. It is output per worker per hour. What is so difficult about that?

The problem is how you define "output". Usually, we take this to mean GDP (gross domestic product), though we might use GNP (gross national product) or GVA (gross value added). In this post, I shall use GDP.

As Diane Coyle has engagingly written, GDP is a deeply flawed measure. Yet we are obsessed with it. The Eurozone uses government debt-to-GDP and deficit-to-GDP ratios to justify harsh spending cuts and tax rises. In the UK, "WE MUST PAY DOWN THE DEBT!" roar the headlines, entirely missing the point that debt-to-GDP is a ratio, so even if we never borrowed another penny, it would rise if GDP fell. Even if GDP growth remained positive, but slowed down - say to 1.5% per annum instead of the predicted 2% -  debt-to-GDP would take longer to reduce for the same nominal amount of debt.

The same applies to the deficit. The deficit is the gap between taxation and spending, expressed as a percentage of GDP. If GDP falls, the deficit automatically widens. If GDP increases more slowly than forecast, the deficit takes longer to close than forecast. So the next time someone says that the fact that the deficit is taking longer to close than the Government predicted means that the Government has "eased off on austerity", tell them to go and learn some basic maths.

And the same also applies to productivity. Productivity is GDP per worker per hour. If the number of workers doesn't change, and the hours that they work don't change, then if GDP is growing, workers are producing more per hour. Their productivity is increasing.

There is thus a firm positive link between GDP growth and productivity. Ceteris paribus, rising productivity means rising GDP.

This is why the OBR's downward revision of UK productivity figures is so devastating. As a direct consequence, the forecasts for GDP over the next five years are significantly lower than before. And this means that the deficit will take longer to close than predicted, and debt-to-GDP will take longer to fall than predicted.

But why should we expect workers constantly to increase their output per hour? Surely there is an absolute limit to the amount that workers can produce per hour. What if we are simply approaching that limit? What if productivity is flat-lining because workers are at full capacity? Are we reaching the limit of GDP growth?

Well, there might be such a limit. But I don't think we are anywhere near it. You see, what enables workers to produce more is investment. And in the UK, investment - both by business and government - is very low.

Let me use an historical example to show how productivity relates to investment. Recently, I have been reading about the Irish potato famine of the mid-19th century. Ireland at the time was part of the United Kingdom and ruled directly from Westminster, so the policy responses to what was by any standards a dreadful humanitarian crisis came from the UK Government. One of the things it did was provide work for unemployed labourers. The work was utterly pointless, building "roads to nowhere" so as not to benefit any particular landowner, or digging holes in existing roads and filling them in again. But it was work, and it paid a wage which was supposed to be sufficient to provide bare subsistence for the labourer and his family.

To start with, they paid the labourers a day rate. But the labourers, worried that when the pointless road was built they would lose their jobs, stretched the work out by doing as little as possible. So the UK government, prompted by public anger in England about the "lazy Irish" (does this sound familiar, Graecophiles?), responded by changing the way it paid the labourers. Instead of paying them by the day, it paid them according to the amount of road they built - we might call this "road inches". This was a productivity incentive: the more road they built per hour, the more they would be paid. The Government's benchmark productivity level would pay workers a subsistence wage.

But there was a problem. In fact there were several problems. Firstly, the Government did not provide equipment - picks, shovels and the like. But the labourers had sold their own equipment for food, so they were forced to dig the roads with their bare hands. Secondly, the labourers lacked road-building skills, since their usual occupation was growing potatoes. And thirdly, the labourers were severely malnourished and often ill. So productivity fell far below the benchmark. The roads were built, but painfully slowly. And the labourers were paid less than half the amount they needed to live. They starved despite being in work.

Now, at this point most of you will say "That's ridiculous. Why didn't the Government provide equipment and training for its workforce? And why did it pay them so little they starved?" Of course, these were roads to nowhere, so nobody really cared whether or not they were built. The Government was simply creating work to justify paying benefits. If the workers didn't work, and therefore didn't get paid, it was their own fault. The Government's conscience was clear.

But just suppose that these were real roads that would have brought real benefit to the economy of the West of Ireland. How could they have been built faster and better?

Well, the Government could have employed more labourers. There was at the time something of a glut of half-starved Irish labourers, so employing lots more would not have been difficult. The roads would have been built more quickly - although as any manager will tell you, there comes a point at which adding additional bodies becomes counterproductive. However, employing extra workers does not raise productivity. It increases the quantity of labour, but the output of each worker per hour remains the same.

The Government could also have increased working hours. Suppose that our labourers were doing a standard 12-hour working day (this was not unusual at the time). The Government could have increased the working day to 16 hours. There's a snag, of course: in the winter, there is a shortage of light. Productivity falls catastrophically when people are working in the dark. But the roads would still have been built more quickly.

However, increasing working hours isn't increasing productivity. It's the same as adding more workers. There is more output, but the output per worker per hour remains the same (or probably worsens, especially in the winter). I've noticed that this is widely misunderstood. Working more hours is not working more productively. As we shall see, working more productively might actually mean working fewer hours.

But what if the Government decided, rather than employing more workers or increasing the length of the working day, to equip its existing workforce with state-of-the-art picks and shovels, plus light and heat so they can work better in the dark, cold winter mornings and evenings? With better equipment, workers could produce considerably more road inches per hour. This is increased productivity. It arises directly from capital investment.

So, let's suppose the Government invests in equipment. The labourers produce more road inches per hour, and their pay therefore rises. In this case, there is a firm positive link between capital investment, productivity and wage growth. However, note that when labourers are paid a day rate regardless of output, there is no such connection.

If labourers are paid more, they can buy more and better food (there was never an absolute shortage of food in Ireland during the famine, only a disastrous shortage of money among the agricultural poor, especially in the West). So their general health improves, and their output therefore increases again.

But even without the equipment, paying the labourers better would improve productivity. In fact as the workforce was half-starved to begin with, providing workers with food and basic healthcare free of charge would probably be a good strategy. Fit and strong labourers produce more road inches than weak half-starved ones, even with poor equipment. Paying people starvation wages is a false economy, unless you think working people to death because there are plenty more where they came from is a reasonable way to run a business.

Now suppose our enlightened Government decides not only to equip its Irish navvy gangs properly, and provide free food and basic healthcare, but to train them in modern (for the 19th century) road-building techniques. Remarkably, their road inches output increases considerably, because they now have both good tools and the skills to use them efficiently. Their pay rises more. They begin to look well and feel happy.

By this time the UK Government has invested rather a lot in its Irish workforce. The combined investment in fixed capital (picks and shovels, light and heat), and human capital (food, healthcare, training) has caused a massive productivity increase. Roads have never been built so fast or so well, and the now-skilled workers are earning more than ever before. Private sector employers, impressed with the new roads, start to move in to poach workers by offering even better pay and conditions. Some are British firms, since they have heard that Irish road builders are the best in the United Kingdom.

Of course, the success of the Government's road-building scheme could cause a problem in an agrarian economy. Indeed it did cause a problem, even though it was nowhere near as productive as the scheme I have described. In 1848, there was famine not because the crops failed, but because they didn't get planted in the first place. Too many people were working on the roads.

However, the fact remains that if the UK Government had abandoned its belief in the morality of work and its laissez-faire economic ideology, and invested in its Irish workforce, many thousands of deaths could have been avoided.

But employing so many people is expensive. They are highly productive, but - could there be a way of reducing the number needed for each road? After all, skilled road builders are in demand. And we still need people to till the fields, anyway.

And so the quest for productivity goes high-tech. Innovation raises productivity far beyond the capability of manual labour, even with high quality picks and shovels. Nowadays, roads are no longer dug by Irish navvy gangs. One man with a JCB can produce more road inches per hour than any number of labourers, and although his pay is higher than theirs, it won't be as much as the total cost of a navvy gang for the employer.  I wrote before about how wages historically have never kept pace with productivity. Of course they haven't. If all the benefit from productivity increases went to the workers, there would be no incentive for employers to invest in productivity-enhancing technology.

Technological advancements have the potential to create massive productivity increases. They also reduce the need for workers. Indeed, the story of the Industrial Revolution is one of declining need for workers. As technology increased worker productivity,  first children, then women (some occupations), and then the old, sick and disabled, left the workforce.

And this brings me to where we are in the UK today. We are going backwards. In the last ten years, the Government has systematically forced back into the workforce the old, the sick, the disabled, and single mothers of young children. The current government continues to insist that as many people as possible must work, and that work must pay. As I have pointed out before, the combination of "everyone must work" with "work must pay" inevitably results in increasingly harsh treatment of those who are unable to work. The imperative to accept any job, however badly paid, puts downward pressure on wages: this, in combination with the belief that those who work must be seen to be better off than those who don't, forces ever-deeper cuts to benefits for those unable to work.

The OBR notes the inverse correlation of high employment (high participation rate) with poor productivity. Indeed, this must be so. For when there is a glut of low-wage, low-skill labourers, and the economic outlook is uncertain, employers have little incentive to invest, whether in fixed assets or human capital. It is much easier to hire and fire unskilled workers at will than to mothball plant or write off investment in training. The flip side of high employment is weak business investment, and this is exactly what we see. The OBR has substantially reduced its forecast for business investment.

The Government seems intent on creating a low-skill, low-wage, high-employment economy. And if that is what we want, I suppose that is what we can have. It would be a stable equilibrium. But it would not be a prosperous advanced economy. That combination is characteristic of poor countries with large populations and wholly inadequate safety nets. Just like 19th century Ireland, in fact.

The Financialisation of Labour - Pieria
Bifurcation in the labour market
The Graves Are Walking - Kelly

The econ nerds among you will note that this post is really an historical deconstruction of the Cobb-Douglas production function.

Image at the head of this post is of the "Famine roads" in Dingle. The visible vertical and horizontal lines on the hills are the scars left by the "roads to nowhere" built by forced labour in the Irish potato famine. Interestingly, there are similar roads in Scotland from the same time: "Destitution road" was built by Scottish potato famine victims.

1. My understanding is that UK low productivity is not just a “batting average effect.” Ie even if you take out the lowest ~5% of workers on the basis “they’d be unemployed in France”, we still have low productivity in comparison with France. So while I agree it’s both pointless and inhumane to force people to work who can’t, ceasing to do so won’t make much overall difference. (Obviously it will make a big difference to the people concerned.)

2. Where does allowing (indeed seemingly encouraging) mass immigration of unskilled labour fit into this argument?

1. Part of Ireland's problem was that the population grew very fast in the late 18th and early 19th century, but the economy did not grow to match it - in fact Ireland deindustrialised in the first half of the 19th century, because its linen industry was unable to compete with cotton. As people returned to the land, it was chopped up into ever-smaller pieces and rented out at extortionate rents to the agricultural poor. Potatoes will grow on soils where grain crops fail, so even marginal land was rented out and tilled for the first time - these marginal plots are known as the Famine Fields. Potatoes are also more nutritious than grains, and take considerably less space to grow, so the agricultural poor were surprisingly well-fed considering their poverty. This encouraged further population growth - even the poorest agricultural labourers often had 6 or 7 children. You could regard this as equivalent to high unskilled immigration encouraging the growth of low-margin service industries, which in turn attract more unskilled immigration.

However, there is an important difference. Irish labourers paid rent to grow potatoes to feed their families. They often paid that rent in labour rather than money - i.e. by working the landowner's land for nothing. Show me an unskilled immigrant who will pay rent to grow their own food.

2. I should add that British policy towards Ireland was driven by the belief that Ireland was over-populated and the excess population should either emigrate or die. Trevelyan described the famine as an "act of Providence". This is why it is now regarded by some as "genocide" - a description that I broadly agree with. As a percentage of the population, more people died in the Irish famine as a direct consequence of British policy than died in Stalin's or Mao's policy-induced famines. It is one of the worst political crimes in history.

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4. I assure you everything I said is factually correct and supported by evidence.

In 1997, Tony Blair formally apologised to Ireland for the British handling of the Irish famine. The Good Friday agreement might not have been possible without that apology.

3. Jerryd Seisyll, your comment has been deleted because once again it consists entirely of personal attacks on me rather than constructive comment on the content of the piece. My comments policy states clearly that I will not publish comments that contain personal attacks on me or anyone else. If you wish to comment, please comment on the piece, not on me.

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4. Very interesting historical stuff in the above article (Irish road building). That’s essentially an example of what is sometimes called “Job Guarantee” (JG): i.e. the idea that there are loads of jobs that need doing, so let’s have government pay people to them instead of handing out unemployment benefit.

The earliest example I know of of that idea being implemented was in Ancient Athens on orders from Pericles around 600BC. The so called “WPA” in the US in the 1930s was another example.

The inefficiency of the “Irish JG” resulted in part from its concentrating on just one activity: road building. I’ve been arguing for the last twenty years that JG people should be dispersed among as wide a variety of types of employer as possible (public and private) so as to reduce that problem.

However I’m not sure about the idea (final paras of the above article) that high levels of employment lead of poor productivity increases. The 1950s and 60s were decades that involved decent productivity increases and high levels of employment.

There is certainly one factor tending to result in high employment levels cutting productivity: it’s the fact that as full employment is approached, each successive person hired is less and less suitable to relevant vacancies. But I don’t see that that’s a good reason to stop aiming for high employment levels: even if shifting from moderately high to very high employment levels of employment (via JG or via regular jobs) involves creating unproductive work, I’d argue that that is better than unemployment, plus it provides work experience for those concerned.

1. Ralph, the inefficiency of this particular "job guarantee" (or rather, "workfare", to give it its correct name) scheme was a feature, not a bug. The Government was determined that the scheme should not "crowd out" private sector employment - though it failed in this, because it did crowd out agricultural labour, as I explained in the post. More importantly, the scheme was funded by ratepayers, who were agricultural landowners. They had a vested interest in ensuring that road building did not benefit other landowners. Therefore the roads could never go anywhere useful. They were, to use an old-fashioned term, "follies".

The British Government had no interest whatsoever in designing an efficient job guarantee system. They were simply creating "work" to justify benefit payments, just as they created "work" in workhouses. I haven't discussed the Irish workhouses here, but they were famous for getting people to do totally pointless work, because anything genuinely useful was believed to crowd out the private sector.

I have yet to see any Job Guarantee advocate examine the Irish famine as an example of the real problems caused by replacing welfare benefits with workfare. The men (and later, women and children) who worked on the roads were starving and ill. They could not physically do the work. They needed food and healthcare FIRST. The British government eventually provided soup kitchens, which replaced the workfare scheme.

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4. Please read what I say a LOT more carefully. In your first comment you have totally misunderstood what I said both in the post and in my reply to Ralph. I am not going to explain it again.

You seem to know nothing at all about the Irish famine. I would seriously suggest you read John Kelly's book "The Graves are Walking". Failing that, Wikipedia has a reasonable summary.

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6. I am not making political points, I am discussing economics. I am very tired of your constant ad hominem attacks. In future, I will summarily delete all comments by you that say or imply that my posts and comments are motivated by politics, financial gain or the desire for fame.

By far the most reliable part of Wikipedia is the citations. I suggest you read them.

5. Is there a reason why we care about productivity (product produced per hour) rather than the aggregate produce (eg GDP) beyond that if we can produce the same with less worker-hours, it's better for the quality of life for the workforce?

I appreciate from your post that greater productivity will be the result of greater investment, and I can see that greater investment will have an immediate benefit for prosperity for the longer term in the way that simply having more workers (and/or hours worked) will not. So investment is very important, but if it's investment we really care about we could look at rates of investment rather than productivity?

Finally, can I check that in your view, one sign of an economy improving in prosperity might in fact be *higher* unemployment (or lower labour participation)?

I have no education in economics so I apologise if these questions are elementary or completely misunderstand the relevant concepts.

Thanks,

"Z.E."

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2. Z.E., these are very good questions.

I do think we should be focusing much more on the causes of low productivity rather than productivity itself. Targeting a residual over which we have no direct control is doomed to failure. So I agree with you. We should be concerning ourselves with rates of productive investment rather than productivity. I have added the "productive" caveat because some forms of investment are much less productive than others. Sadly that includes the investment that British people most often make, namely property. I suspect that one of the principal reasons for historically low levels of business investment in the UK is the highly distorted property market. Bluntly, the returns on property are both higher and more certain than the returns on business investment.

Yes, in my view falling labour force participation and working hours can be a sign of rising prosperity. Particularly, falling female participation can often be a sign of prosperity - the non-working wife is a male status symbol. But only if GDP per capita is also rising.

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7. Thanks for a very informative and well written article.
I found it a very interesting read and very educational.

MPC

8. Very informative article. Could you comment on whether you think if high land values and rent contribute to the poor productivity outcomes currently (last 20 years)in the UK . I'm not sure if the proliferation of coffee shops serving high priced coffee, served by minimum waged, subsidised labour, in high rent establishments does anyone any favours in this respect except the owners of the coffee shops and the landlords.

9. Brick says.

Whilst I totally agree with the sentiment about the path we are on I have a nagging doubt that there are mechanics to investment which are important, highlighted by the historical possible policy decisions discussed.

When we have policies like reducing redundancy rights, lowering pension responsibilities, crippling safety nets, pay grading, on top of forcing people into work it is no wonder wages fail to keep up with inflation. This depression inducing policy which the UK seems in love with has wide reaching effects on productivity, investment and research and development.

The trading environment result is that established markets tend to slightly shrink in volume while customers trade downward to cheaper prices and quality. The available business responses are to innovate into new market segments (R&D), cost cut materials and wages , diversify into new products , consolidate the supply chain, provide associated services and market acquisitions. These choices have different risk profiles and the choice is often driven by job security expectations for decision makers. For the UK the optimum risks seem to drive choices towards cost cutting, market acquisitions and supply chain consolidation. Cost cutting often produces disenchanted disloyal employees which are under productive. Repeated market Acquisitions lead to disjointed unproductive corporate components. Consolidation of retail ,wholesaling and manufacture lead to increased corporate complexity dropping productivity. On top of this is a drive to include services with a product, and a need to monitor market trends more closely. These require extra process steps and affect productivity and ultimately cut tax receipts.

Looking at the Todd Mitton's paper on Corporate diversification and labour productivity and the IPTS Working paper on corporate R&D and innovation you can see why certain environments lead to lower productivity due to misallocation of capital, reduction into efficiency due to industrial diversification , value-reducing strategies due to managers with short term incentives. I freely admit to being wrong about this or even missing the point of the post, but it seems to me that how capital is allocated and investment increased is important. Taking the historical example if the government policy had been to cut road building material quality, make the Irish create their own picks and shovels, sell tickets to watch the Irish work and sing, outsourced management to the Mafia, insisted workers carry a bucket of water for safety, bought robots to accurately measure progress then productivity might have been worse. What I think you have shown is a need for focus on investment in people to create the environment for good investment and innovation otherwise those last few steps towards the introduction of work houses and mental asylums will happen quicker than it would take me to cut this comment to a more focused size.

10. I agree that the government is headed toward a low skill, low wage high(ish) employment scenario. The article starts with productivity and we hear the wiseacres declaring that 'more education, more productivity' are what is needed for a successful economy.

But I ask what sort of social setup is more productivity and more education supposed to connect with? I suspect more productivity would only be worthwhile in some new and expanding sector of the global economy and won't be in the UK whether post Brexit or not. Why would anyone build a new robot factory here or set up a new service centre here when they have the choice of all the EU, non-EU and ROW to choose from. Our new governing class has looked at the consequences of more productivity and education and seen that it does not like the result.

To allow new big factories and new big services would offend our planning rules and lead to a newly powerful working class, exactly what the governing class doesn't want. A burgeoning new upper working and middle class would want housing and roads etc etc. That spells trouble. Far better to keep them in rented and living with M&D.

Similarly with education. In real terms we are spending less in real terms on a per pupil basis. Given a deliberately constrained economy the last thing the governing class need is a well educated population. A 'good' education must be bought expensively from our universities. The resulting product makes for the most part reasonable fodder for a lack lustre corporate life, an expensive house (if ever) and insufficient money for intergenerational improvement.

So in the end we will hear 'more productivity' as a stick with which to beat business and workers whilst deliberately constraining the economy and we will hear 'more education' but no money will be found for anything serious and no jobs here to put that education to much use.

My advice FWIW is to send your kids to private school and help them emigrate as fast as possible, or get a job on a quango or the DT.

11. Frances.

I very well thought out piece but I don't think you've been looking that hard for a in depth Job Guarentee economic paper.

Here's 2 articles that cover all of your points.

1) ‘Maximizing Currency Stability in a Market Economy’ that Warren co authored with Professor Damiano Silipo that is currently working its way through the EU.

2) Thoughts about the Job Guarantee: A Reply A response to the Nov 17 thoughts of Simon Wren-Lewis by Neil Wilson

http://authors.elsevier.com/sd/article/S0161893817300017

1. As this blogpost isn't about Job Guarantee policies, it is hardly surprising that I did not look for an in depth Job Guarantee economic paper when writing it. The correct term for the British scheme during the Irish famine is "workfare", and that is the term I used in my response to Ralph Musgrave.

2. I have now read the Medium post, and it does not even mention the workfare scheme in the Irish famine, let alone consider the reasons why such a scheme was created and what measures would be needed to prevent a Job Guarantee scheme degenerating into workfare at the margin.

If you wish me - and others visiting this site - to read Mosler's article, please provide an ungated link. I'm not going to pay Science Direct's exorbitant charges to read a paper that may or may not have anything to do with the subject of this post.

And finally, I remind you that my comments policy requires you to stick to the topic of the post. This post is not about Job Guarantee. Please discuss the points raised in the post, rather than grandstanding your own agenda.

3. Frances,

I can assure you there is no grandstanding. It was a reply to what you said to Ralph so was clearly on topic.

"I have yet to see any Job Guarantee advocate examine the Irish famine as an example of the real problems caused by replacing welfare benefits with workfare."

Why would they consider the Irish Famine when all the solutions to the real problems have been covered extensively for nearly a decade now in various economic papers. They show quite clearly that if implemented as they suggest a Job Guarantee scheme would not degenerate into workfare at the margin.

There is no problem that the Job Guarentee does not fix if implemented correctly and it is a million miles better than what we currently have. More importantly it would improve productivity considerably.

I think now is the time to have an open debate about it preferably on TV as it is long overdue. Which can only be a good thing and it would promote a healthy academic debate.

I really enjoyed your piece above but the authors of all the Job guarentee literature don't need to go as far back as that to see what problems needed to be fixed.

4. I said that the Job Guarantee research literature did not appear to include an evaluation of the workfare scheme in the Irish famine. You told me I hadn't looked hard enough, and provided a couple of links, one of which I can't access. You have now told me that the reason the Irish workfare scheme is missing from the Job Guarantee research literature is that Job Guarantee researchers don't need to look at the mistakes made in the Irish famine. That proves my point, does it not?

12. Very good article, indeed. So, would you say that the UK government is now reducing the potential GDP per capita because of its “well intentioned” labor policy? thanks.

1. I'm not very familiar with the UK, but I presume the labour policy you refer to would reduce potential GDP **per worker** (larger labour force with a lower average level of productivity) but possibly (they hope!) increase potential GDP **per capita** (larger labour force = more output, even if the average worker produces/earns less).

13. I liked this very simple explanation for poor productivity in the FT letters:
https://pbs.twimg.com/media/DMIL3ThWkAM7Ndn.jpg
Essentially a demand deficit in a UK economy that is relatively flexible regards ease of employment and with (until recently) a ready supply of labour from the EU periphery.

Regards The job guarantee, important to state that JG =/= workfare
A proper program would have recipients undertaking productive endeavours with training and at a ;iving wage.

How would you stop it becoming workfare?

The same way that you prevent private employment becoming exploitative and demeaning, with regulations that are enforced and with appropriate investment and oversight.

14. The mistakes that JG proponents make are the same as the UK government is making with Universal Credit, namely assuming that everyone can work, and that jobs people are directed to do are of more value than work they create for themselves. Where do those who can't work, for example because they are terminally ill, fit in a JG programme? How do you determine who should be offered work and who should not? Do you still give benefits to those who can't or won't work? How do you tell the difference?

The Irish scheme assumed that people could and should work even though they were starving and ill. The workhouses had the same ethic - people were put to work regardless of their age and their state of health. Whether or not the jobs were productive is not the point. The problem is the compulsion to work. And I don't buy the "job guarantee is voluntary" argument. If all you offer someone is a choice between work or starvation, it is not a real choice.

JG could be extremely powerful if underpinned by something like a universal basic income. Without that, it would inevitably tend to become workfare at the margin.