By Peter De Coensel,


Broad historical economic research posits that inflation and productivity are negatively correlated. Most OECD countries had low productivity and high inflation back in the 70s. In the US, tentative productivity improvements over the 80s accelerated over the 90s, pushing the average towards 2.5% above the 2.1% long-term US trend productivity level. Over that decade, inflation glided towards comfortable levels, back then, between 2% and 3%. The diffusion of digital technologies was due to lift US productivity growth, which was reaching high levels (ranging between +2.25% and +4.25 from 1998 to 2005), but gave birth to a productivity paradox, leaving average productivity growth just below 1% over 2010 to 2019.

The high pace of adoption of digital solutions merely caused short-lived productivity boosts. Even with elevated technological progress these days, we seem to struggle to adapt our organisational and business models to innovations. Productivity growth driven by big data, Internet of Things, artificial intelligence, robotics, or 3D printing will take more time before impacting the slow-moving real economic productivity variable. There is a school of thought that puts lack of managerial and overall ICT skills within organisations as the single biggest reason for a breakdown in the rate of technology diffusion. What clearly stands out is that the long-term decline in productivity growth relates to the shift from manufacturing towards service-based economies. To complicate things even further, we notice that the average consumer embraces personal services that carry low productivity across food, transport and hospitality industries.

The 2020 surge in global productivity did not hang around for long. In 2020, ‘GDP per hour worked’ —a standard definition of labour productivity— saw its largest year-on-year increase since the 1970s: +4.5% globally, including +2.6% in the US. The +4.5% productivity growth over 2020 was spilt across developed markets (DM) at +1.3% and emerging markets (EM) at +6.0%. Over 2021, productivity growth settled at +1.4% across DM (with the US at +1.2% and the EU at -0.1%!). The expectations for 2022 are dire, as another year of stagnant productivity is in the offing. GDP per hour worked is poised to contract by −0.2% in 2022. These declines range from −0.2% in the US, to −0.9% in Germany, −1.3% in the UK, and −2.2% in Japan. EM markets are expected to pencil in a disappointing +0.2% number.

With persistent supply disruptions pushing out inflation normalisation and the war in Ukraine increasing economic uncertainty and decreasing consumer confidence, sustained economic growth can only be achieved through considerably higher productivity growth. Firms that want to remain competitive with rising input and labour costs will be required to propel productivity growth through innovation, restructuring, digital transformation, automation, improving efficiency, and, or investment in new business models.

If the next decade mirrors the previous one in its inability to strengthen trend productivity, the cost of doing business will rise, as companies face a rapid growth of unit labour costs. To offset this pressure on profit margins, most firms will need to raise prices. Expect this outcome to start impacting network business models as well as more traditional business models. But, eventually, at the end of the day, the labour force bargaining power will drop and they’ll have to accept slower wage growth given the lack of productivity growth. Such an adjustment period requires time, so inflation might persist for longer than expected. additionally, and unavoidably, slower productivity growth will give way to a drop in aggregate demand and take inflation back to the current distant 2.00% target or lower.

Let’s briefly return to the 3 components at the source of productivity growth. First there is the pace at which capital per employee is rising over time (also called capital deepening). Second comes an improvement of labour quality and skills or human capital. Third is multifactor productivity or all things beyond capital deepening and improving workforce skills that is commonly labelled as the technology or innovation component. We addressed the issue above with technological progress, where time and broad-based adoption are key ingredients to establish a productivity lift.

Still, across the other two components, we (will) also receive more headwinds than expected. The requirement for capital deepening to grow the productive capacity and ultimately the potential growth of an economy should receive more attention. Capital Stock divided by Total Labour supply equals the capital-per-worker ratio. This ratio needs to grow through increasing capital stock (increase in net investment – gross investments adjusted for depreciation) or reduction in the total labour supply. Total labour supply combines population growth, the participation rate and net immigration. Increasing the capital stock is fed by high savings rate and accommodative funding costs.

With inflation well above average, savings become less potent, thereby tightening financial conditions, which might start to depress investment willingness. Moreover, economic theory states that marginal productivity of capital deepening is bound to level off. The labour mismatch currently keeps labour markets in a state of scarcity and capital deepening sound. However, as millennials are becoming dominant, the quality of the labour market and the overall supply should rise. Encountering reluctant corporates in their hiring willingness could start to push unemployment higher. Combining the above trends might not bode well for capital deepening but result in capital widening at best or decreasing capital intensity at worst. Under capital widening the increase of the capital stock is similar to the increase of the labour force.

Overall, the outlook is not that rosy for productivity growth, whilst being an essential ingredient to alleviate the effects of inflation across goods and services but especially against the super core wage inflation factor. I want to quote Krugman writing in his book “The Age of Diminished Expectations” back in 1994: “Productivity isn’t everything, but in the long run it is almost everything”. The FED still holds onto long-term US real potential GDP growth at +1.8%. Hours worked, productive capital stock, capital quality as well as technology and innovation (multifactor productivity) will need to fire on all cylinders to potentially reach 1.8% in real terms. The current inflation is bad inflation from the cost-push kind. It’s also the kind of inflation that is not conducive to improving productivity.


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