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The secret of productivity growth is not technology

By World Economic Forum | August 8th 2021
By World Economic Forum | August 8th 2021

Paul Odiwuor at his aquaponic farm in Kawiya village, Rangwe, Homa Bay County.

The idea that technology drives productivity growth is a commonplace and a common frustration. Economies operating at or near the technological frontier have long seen sagging trend growth rates despite marvellous technology – from artificial intelligence to bioengineering to robotics – proliferating at breakneck speed.

This matters because productivity, or output per input, pays for higher wages and is the foundation of long-run prosperity.

In that sense, it matters most in rich economies where higher productivity growth would allow political debates to shift from (re-)distributing a relatively stagnant economic pie to sharing a growing one.

Yet, there is an often-overlooked factor in the debate about technology and growth. Yes, technology undoubtedly plays a critical role, but we should think of it as the fuel of productivity growth. The spark is provided by tight labour markets, i.e. when firms are forced to better utilise technology because they cannot add labour easily.

Understanding the spark of productivity growth

Availability is often not enough to prompt broad adoption and utilisation of technology – integration can be costly and there may be implementation risks. It is often easier for firms to continue to grow with the next incremental hire.

When labour markets are tight and wage growth runs above long-run trends, however, firms will face downward pressure on margins even when revenue is growing. Such a pressure cooker economy can force executives, managers and workers to adopt and better utilise existing technology, instead of looking to an expensive labour market for extra capacity.

While the frontier of technology can diffuse around the globe through trade and global value chains, the labour market conditions that provide the spark for adoption are far more localised. This means that productivity growth may diverge in countries with similar technological capabilities.

Rapid tightening - or loosening - of labour markets can occur as the byproduct of strong cyclical dynamics (such as the recovery currently underway). Or it can happen as the result of the structural organisation of local labour markets.

Balancing the risks and benefits of tight labour markets

Ignoring the benefits of tight labour markets could come at a cost for policymakers and executives. Take once more the US economy. It is on a path to achieving higher output in 2024 than was once expected pre-pandemic, i.e. “overshooting” its old trend path. Owing to strong and sustained fiscal stimulus, the rapid return to labour market tightness has been framed as an inflationary threat.

Our own view has been that the price growth of recent months relates to transitory mismatches as the economy reopens.

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