March 2, 2021

When trends aren’t a straight line of progress (part two): Productivity—why global progress has stalled

If we want to build a bright future for all Canadians, we need to think deeply about how to unlock our collective productivity. In the first commentary of our Productivity Series, we explain why economists have something of an obsession with this concept; illustrate its impact in improving our lives; and dispel a common myth that increasing productivity decreases the number of jobs available.

While it is tempting to dive into Canada’s own performance next, it is difficult to fully understand it outside of the global context. Therefore, in this commentary, we dig into something economists have been waving red flags about for years: The Global Productivity Slowdown. We assess the causes of this slowdown based on available research and consider how COVID and digitization could either upset or exacerbate this trend.

When unstoppable progress stalled

Generations of Canadians and millions across the globe today enjoyed the benefits of strong productivity growth as the result of the Second Industrial Revolution. This period—fueled by wide-spread access and use of electricity, the introduction of mass production techniques to produce household products, better business management strategies, and greater educational attainment of the workforce—ignited rapid and sustained productivity growth for decades across advanced economies, with increases of roughly 3% per year from 1920 to 1970.

The workforce also began to better reflect the diversity of the customers it served as women entered the workforce in droves and legislation and policies were put in place to limit racism and discrimination. The productivity gains due to more education, new technologies, and greater inclusion translated to increased wages and standards of living along with more paid leave and leisure time.

Then, what felt like an unstoppable trend of upward progress stalled. Since 1970, productivity has increased by just 1-2% per year in most countries. Median earnings have not grown with the same vigour, and inequality has risen in many countries, along with social tensions. These trends have given rise to populist movements, policies of protectionism over free trade, and an emphasis on nationalism over global cooperation.

Since 1970, the biggest period of human ingenuity was what some call the Third Industrial Revolution which reached critical mass in the 1980s. Thanks to cordless phones, personal computers, and the internet, it was the start of faster, easier, and cheaper information sharing across the globe. This period also introduced electronics—from the Walkman cassette recorder to the Gameboy by Nintendo—into our daily lives.

Yet, except for a short bump in the 1990s, these changes did not translate into large-scale, long-lasting productivity gains.

What happened to productivity?

Why haven’t we seen the same strong gains in productivity more recently as we saw in the past? Many families now find that they need two adults working full time, often with side gigs, just to afford a middle-class lifestyle and might not feel that they are better off than their parents.

There is no shortage of theories, and it’s worth noting that many economists contend we just don’t know for sure. Below, we synthesize the most noted ideas into three overarching themes:  

  • We’re not measuring productivity accurately;
  • “Easy gains” have already been exhausted; and
  • The Financial Crisis caused a further slowdown.

For a reminder of what drives productivity growth, see Part I, section “How does a country increase its productivity?”

We’re not measuring productivity accurately.

Why productivity growth might actually be higher

Some economists believe that there has been a substantial increase in productivity over the last few decades. We’re just not capturing it adequately in our measurements.

As a reminder, productivity is calculated by taking the value of all goods and services produced—as measured by GDP—divided by the total number of hours worked. In other words, how much value was produced (output), given the number of labour hours put into making it (input)?

The problem is the methodology for most key measures of the economy—including GDP—was largely determined in the 1930s and thus they measure the world as it was then (predominantly local supply chains which produced physical products) better than the world as it is today (increasingly, global supply chains, with greater emphasis on services and intangible assets).  

For instance, most innovations of the Third Industrial Revolution—for example, a cell phone—have improved in quality and grown in functionality since introduction, but with the automation of factories and global supply chains, have also dropped in price. Meanwhile, other valuable services such social media platforms and Google are essentially free to the consumer. If the measurement of GDP does not make adequate adjustments for this, it will seem like the workforce is creating less “value” when it is actually creating more.  

However, even the highest estimations of this phenomenon find this to explain just a fraction of the global productivity slowdown.

Why productivity growth might actually be lower

Another argument over mismeasurement comes to the opposite conclusion: the decline in productivity is actually even greater than it appears. The dispute here is over “input” measure—we are undercounting hours worked. Thanks to the internet, it is easy to work a couple more hours after you put the kids to bed or to catch up on work emails periodically throughout your vacation, yet this is unlikely to be fully captured in the data. This undercounting would inflate our productivity measures. While something to consider, this theory has not been corroborated by research.

“Easy gains” have already been exhausted.

Gains in human capital have stagnated

More education leads to greater productivity and wages, in addition to yielding positive benefits for society at large. Though educational attainment increased substantially from 1920 to 1970, it has moderated since.

From 1920 to 1970, the share of the world’s population over 15 with formal, basic education increased from 38% to 63%. This measure, unsurprisingly, goes hand-in-hand with increases in literacy, a critical skill for most jobs. Since 1979, these have continued to grow but at a slower rate.

Specifically, educational attainment in many advanced economies seems to have plateaued since about 1980. For instance, in the US, the mean number of years of schooling increased from about seven in 1920 to 11 in 1970 (a 70% increase) but has been stuck between 12 and 13 since 1980.

At the same time, there is an open question of whether educational institutions—the general structure of which came about in the late 1800s—have sufficiently adapted to the skills needed in today’s economy: to synthesize large amounts of information, manage distractions and information overload, and pivot into new jobs and careers. That is to say, the quality and relevance of education matters more than the number of years of schooling.  

Limits of structural transformation

To realize the biggest gains of productivity, an economy needs a healthy dose of dynamism, where workers can seamlessly transition from one industry to another in response to changing needs.  

A key dynamic which drove the increase in overall productivity from 1920 to 1970 was a change in the composition of the workforce from agriculture to manufacturing. This transition from an industry with relatively low labour productivity to an industry with relatively high productivity meant large overall gains.

It also ignited another productivity-enhancing trend: people increasingly moved from rural areas to urban centres—hubs for collaboration, knowledge-sharing, and research and innovation. These trends are not just true of advanced economies; most emerging economies have done likewise.   

The current labour force transition—from manufacturing into services—does not come with the same gains, in part because, at least so far, there are fewer opportunities for standardization within this work. Meanwhile, the growth of cities continues but at a slower pace.  

In other words, the big transformational gains from agriculture to manufacturing—and rural to urban—may have already been realized. Meanwhile, the transition to services may not only come with smaller overall gains, but it also creates a divide between the opportunities available for those with greater physical versus mental skills, building disenfranchisement within segments of the population and fraying social cohesion.  

The Financial Crisis caused a further slowdown.

Dampening capital investment

The Financial Crisis, which began in 2008, further dampened progress in what consulting firm McKinsey calls the Second Wave of the Productivity Decline (the first following the short boom in the 1990s). That crisis—like most economic downturns—scarred the global economy with increased uncertainty, strained balance sheets, and weak consumer demand. And its impact lingered for years.  

Importantly, for several years following the crisis, businesses did not invest in the tools and equipment that make workers’ jobs easier at the same pace as they did before. Two forces were at play. First, increased risk-aversion meant businesses hired back workers after the crisis but invested little in physical capital (computers, software, machines) which help workers do their jobs better. Besides, consumers were reluctant to spend, so businesses wanted to keep costs low. Moreover, weak balance sheets meant it was more difficult for many businesses to borrow the money necessary to make these investments.

The effect was that the “capital intensity,” or the amount of tools and technology per worker, increased at its slowest rate since WWII. This factor is a big one; it alone may account for more than half of the decline in productivity in recent years.

Though the Financial Crisis did not affect all countries the same, the decline in capital has been near universal across developed countries. This may be because of “spillover effects” where trends among large players like the US—which was most directly affected—impact other economies.  

A growing divergence between strong and weak businesses

Though this trend likely began prior to the Financial Crisis, the legacy of record-low interest rates and government bailouts made it worse. It allowed low productivity firms to shuffle along instead of giving way to newer, more vibrant start-ups. These low productivity businesses lag in technology adoption and better management practices, weighing down productivity and limiting the competitiveness of the industry. This is why economists are often wary of bailouts and other market distortions because, though they may protect jobs in the short run, they can ultimately come at great cost to society in the long run.

As a result, there has been a divergence between high- and low-productivity firms. This also helps to explain the rise in income inequality. Highly productive businesses tend to pay their workers more while low productivity firms pay less. Essentially, household incomes are dependent on a business’s ability to grow through greater productivity.

What’s next?

Some believe progress has simply yet to materialize. After decades of low growth, we will soon see the impact of what is known as the Fourth Industrial Revolution—digitization and technological advancements such as 5G, Big Data, Machine Learning, and 3-D printing, to name a few. It will simply take time for businesses and workers to learn about and invest in these new technologies and figure out the best ways to use them to improve their work. 

Furthermore, The Economist says COVID could be the upset needed to encourage adoption and use at the scale necessary to realize gains. It is easy to identify examples that confirm this theory: data visualization and sharing has accelerated with sources like Johns Hopkins coding COVID data in a way that informs policy and educates the public; grandparents are now well versed on Zoom and Facetime to communicate with grandchildren; and doctors have learned to maximize their time by prioritizing certain cases in person and others online.

But support will be needed to embolden these opportunities while limiting the counterproductive trends at play—school and work interruptions, mental health issues, and physical ailments that have gone unaddressed, to name a few. Countries that harness these transformational opportunities while limiting their harmful effects will have the strongest recovery which gives way to long-lasting improvements in income and quality of life for all. Following our next commentary—which will compare Canada’s performance with the US—our fourth and final commentary will review and identify opportunities to do just that.  

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