Productivity measures output per unit of input (nature, people, capital & enterprise). Productivity is defined as the efficiency of respective production systems. Productivity from a companies’ perspective defines profits, clears debt, increases product or service volumes, and maintains or expands market share. The human labour factor, workers, should receive higher wages, better working conditions and an overall higher standard of living. As a customer it translates into more product availability, supply certainty next to possible price reductions. Productivity is a key factor that defines both long-term growth and the growth of the labour market. Its all about working smarter, not necessarily working harder.
Over the past year the inflation debate has been left, front and center. The link with historical episodes after World War II and across the 1970’s has been flagged in order to convey a message that downplays inflation, weighing it as transitory, or otherwise, pushing the impact of the current inflationary scare by warning for persistent above target inflation over the next 5 to 10 years. In the next paragraphs, I take a different perspective, putting productivity as a starting point. That enables thinking along potential growth lines. It enables as well to what extent monetary policy will be able to support asset inflation.
Just after WW II, US inflation spiked but settled on an average of 2.3% between 1948 and 1969. Interestingly, per capita GDP growth, an expression of productivity at the level of economic output, across the US and Europe stood at about +3.1% per annum. Economic progress was widespread and effectively inclusive. The middle class took shape across the US and Europe. (Potential) real growth in the West got a boost and became persistent as labour growth and productivity was robust. A lift in education quality, a broadening labour force participation and a renewed economic fabric lifted overall welfare. Between 1973 and 1983, productivity dropped off a cliff towards 1.3%, defining the stagflation era. High unemployment was part of the mix. Demand growth was supported by increased public social spending and investment against restrained supply growth given respective energy shocks. Between 2008 and 2019, the post Great Financial Crisis episode, productivity growth fluctuated around 1%. However, an interesting feature became visible over the past decade.
Productivity growth from frontier industrial firms came in about 3% per annum higher than firms presented in the middle of the pack. Moreover, within the services sector leading firms advanced the peloton by an impressive 5% per annum in productivity growth (source: McKinsey Report March 2021). As always, it pays to step away from simple averages and have a closer look. It becomes evident that superstar, global companies across on-line services, technology solutions, healthcare or communications are responsible for intense productivity gains. These mega firms support and lift the average productivity numbers. It also reflects a profound lack of productivity diffusion. The pandemic has not changed this reality. If anything, the pandemic has increased the gap between most productive firms (and countries) and the least productive ones. Within logistics, transport as well as finance/banking productivity gains have been limited but disruptors are present.
Under an optimistic scenario that sees the world economy exiting the pandemic over 2022, an essential feature that is required to achieve country- (DM & EM) and sector-wide higher productivity readings consists of a sustained public investment effort. Such an effort was clearly lacking until 2019. Restoring the supply side is paramount. Large-scale, continued fiscal support by governments will need to take over the baton from large-scale monetary support by central banks. The Biden infrastructure and societal programs are necessary conditions. Same goes for the EU Next Generation subsidies and loans. Question remains if these will prove to be sufficient to raise productivity. The help of big government is required to lift potential supply growth. Other necessary conditions stack up as follows. The skills mismatch requires urgent address, as it puts a brake on quick wins. With monetary policy accommodative, credit channels are available for capital accumulation and investment. However, the human capital factor is an essential ingredient to achieve productivity growth. Southern Europe is a point in case where reduction in systemic skill mismatches might provide an enormous boost to productivity growth. Next, positive business dynamics will be required for broad-based productivity gains to take hold. Indicators that one should track closely is M&A activity, overall R&D spent and overall green and corporate capex strategies.
In parallel to mending supply-side growth, delivering sustained demand growth is required. Governments alongside companies need to be aware that the labour share of income requires attention. How do these risks line-up? First, productivity gains that are achieved by cutting labour, pulling the automation card will increase the divide. Winner (superstar companies) takes all as productive benefits are distributed among the few. Second, the above condition can become so strong that it reduces the will to invest. High regulatory and sector specific hurdles are stifling entrepreneurship. On the other side of the spectrum, many incumbents grapple with the climate-related transformational impact on capital strategies. Worries run high on rolling over current indebted balance sheets the moment buy-side investors start calculating climate-adjusted credit ratings. That brings us with the third risk factor that might impact governments and corporates: debt sustainability. Fiscal constraint by governments or hesitation in capital or operational expenditure plans might impact aggregate demand negatively.
The productivity debate deserves more airtime and attention by investment and political actors alike. Living in a climate constrained world is increasing the complexity manyfold. I cannot predict what school will win out in this debate. The school that calls for a return in a low, slightly positive productivity scenario. That school is convinced that the IT revolution has run its course and expected benefits across automation or biotech are limited. It’s a school that sees continued narrow leadership and persistent inequality. The other school calls for above average productivity growth (2%+) as improved diffusion is reached across government and private economic agents.
This productivity debate will shape the journey of rates, credit and equity markets and expected returns for investors, large and small.
