Productivity: More with Less by Better

Available resources are scarce. To sustain our society's income and living standards in a world with ecological and demographic change, we need to make smarter use of them.

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In a nutshell

Nobel Prize winners Paul Samuelson and William Nordhaus state in their classic economics textbook: Economics matters because resources are scarce. Indeed, productivity research is at the very heart of economics as it describes the efficiency with which these scarce resources are transformed into goods and services and, hence, into social wealth. If the consumption of resources is to be reduced, e. g., due to ecological reasons, our society’s present material living standards can only be maintained by productivity growth. The aging of our society and the induced scarcity of labour is a major future challenge. Without productivity growth a solution is hard to imagine. To understand the processes triggering productivity growth, a look at micro data on the level of individual firms or establishments is indispensable.

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Productivity is output in relation to input. While the concept of total factor productivity describes how efficiently labour, machinery, and all combined inputs are used, labour productivity describes value added (Gross Domestic Product, GDP) per worker and measures, in a macroeconomic sense, income per worker.

Productivity Growth on the Slowdown

Surprisingly, despite of massive use of technology and rushing digitisation, advances in productivity have been slowing down during the last decades. Labour productivity growth used to be much higher in the 1960s and 1970s than it is now. For the G7 countries, for example, annual growth rates of GDP per hour worked declined from about 4% in the early 1970s to about 2% in the 1980s and 1990s and then even fell to about 1% after 2010 (see figure 1).

This implies a dramatic loss in potential income: Would the 4% productivity growth have been sustained over the four and a half decades from 1972 to 2017, G7 countries’ GDP per hour would now be unimaginable 2.5 times as high as it actually is. What a potential to, for instance, reduce poverty or to fund research on fundamentals topics as curing cancer or using fusion power!

So why has productivity growth declined dramatically although at the same time we see, for instance, a boom in new digital technologies that can be expected to increase productivity growth? For sure, part of the decline might be spurious and caused by mismeasurement of the contributions of digital technologies. For instance, it is inherently difficult to measure the value of a google search or another video on youtube. That being said, most observers agree that part of the slowdown is real.

Techno-Pessimists and Techno-Optimists

Techno-pessimists say, well, these new technologies are just not as consequential for productivity as, for instance, electrification or combustion engines have been. Techno-optimists argue that it can take many years until productivity effects of new technologies kick in, and it can come in multiple waves. New technology we have now may just be the tools to invent even more consequential innovations in the future.

While this strand of the discussion is concerned with the type of technology invented, others see the problem in that inventions nowadays may diffuse slowly from technological leaders to laggards creating a wedge between few superstar firms and the crowd (Akcigit et al., 2021). Increased market concentration and market power by superstar firms may reduce competitive pressure and the incentives to innovate.

Finally, reduced Schumpeterian business dynamism, i.e. a reduction in firm entry and exit as well as firm growth and decline, reflects a slowdown in the speed with which production factors are recombined to find their most productive match.

While the explanation for and the way out of the productivity puzzle are still unknown, it seems understood that using granular firm level data is the most promising path to find answers.

What are the Origins of Productivity Growth?

Aggregate productivity growth can originate from (i) a more efficient use of available inputs at the firm level as described above or (ii) from an improved allocation of resources between firms.

Higher efficiency at the firm level captures, e.g., the impact of innovations (Acemoglu et al., 2018) or improved firm organisation (management) (Heinz et al., 2020; Müller und Stegmaier, 2017), while improved factor allocation describes the degree of which scarce input factors are re-allocated from inefficient to efficient firms (‘Schumpeterian creative destruction’) (Aghion et al., 2015; Decker et al., 2021).

Most economic processes influence the productivity of existing firms and the growth and the use of resources of these firms and their competitors as well. The accelerated implementation of robotics in German plants (Deng et al., 2020), the foreign trade shocks induced by the rise of the Chinese economy (Bräuer et al., 2019), but also the COVID-19 pandemic, whose consequences are still to evaluate (Müller, 2021) not only effects on productivity and growth of the firms directly affected but at the same time may create new businesses and question existing firms.

While productivity can be measured at the level of aggregated sectors or economies, micro data on the level of individual firms or establishments are indispensable to study firm organisation, technology and innovation diffusion, superstar firms, market power, factor allocation and Schumpeterian business dynamism. The IWH adopts this micro approach within the EU Horizon 2020 project MICROPROD as well as with the CompNet research network.

As “creative destruction” may also negatively affect the persons involved (e. g., in the case of layoffs, Fackler et al., 2021), the IWH analyses the consequences of bankruptcies in its Bankruptcy Research Unit and looks at the implications of creative destruction for the society, e. g., within a project funded by Volkswagen Foundation searching for the economic origins of populism and in the framework of the Institute for Research on Social Cohesion.

Publications on “Productivity”

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Lessons from Schumpeterian Growth Theory

Philippe Aghion Ufuk Akcigit Peter Howitt

in: American Economic Review, No. 5, 2015

Abstract

By operationalizing the notion of creative destruction, Schumpeterian growth theory generates distinctive predictions on important microeconomic aspects of the growth process (competition, firm dynamics, firm size distribution, cross-firm and cross-sector reallocation) which can be confronted using rich micro data. In this process the theory helps reconcile growth with industrial organization and development economics.

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Private Equity, Jobs, and Productivity

Steven J. Davis John Haltiwanger Kyle Handley Ron S. Jarmin Josh Lerner Javier Miranda

in: American Economic Review, No. 12, 2014

Abstract

Private equity critics claim that leveraged buyouts bring huge job losses and few gains in operating performance. To evaluate these claims, we construct and analyze a new dataset that covers US buyouts from 1980 to 2005. We track 3,200 target firms and their 150,000 establishments before and after acquisition, comparing to controls defined by industry, size, age, and prior growth. Buyouts lead to modest net job losses but large increases in gross job creation and destruction. Buyouts also bring TFP gains at target firms, mainly through accelerated exit of less productive establishments and greater entry of highly productive ones.

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Corporate Venture Capital, Value Creation, and Innovation

Thomas J. Chemmanur Elena Loutskina Xuan Tian

in: Review of Financial Studies, No. 8, 2014

Abstract

We analyze how corporate venture capital (CVC) differs from independent venture capital (IVC) in nurturing innovation in entrepreneurial firms. We find that CVC-backed firms are more innovative, as measured by their patenting outcome, although they are younger, riskier, and less profitable than IVC-backed firms. Our baseline results continue to hold in a propensity score matching analysis of IPO firms and a difference-in-differences analysis of the universe of VC-backed entrepreneurial firms. We present evidence consistent with two possible underlying mechanisms: CVC's greater industry knowledge due to the technological fit between their parent firms and entrepreneurial firms and CVC's greater tolerance for failure.

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The Technological Role of Inward Foreign Direct Investment in Central East Europe

Johannes Stephan

in: The Technological Role of Inward Foreign Direct Investment in Central East Europe, 2011

Abstract

Foreign direct investment (FDI) assumed a prominent role in Central East Europe (CEE) early on in the transition process. Foreign investors were assigned the task of restructuring markets, providing capital and knowledge for investment in technologically outdated and financially ailing firms.

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A strategy view on knowledge in the MNE – Integrating Subsidiary Roles and Knowledge Flows

Björn Jindra

in: East-West Journal of Economics and Business, 1 & 2 2005

Abstract

We assume knowledge inflows endogenous to subsidiary roles. Integrating organisational and knowledge-based views we propose a new subsidiary typology based on MNE integration-subsidiary capability. We hypothesise that both dimensions are positively associated with knowledge inflows into the focal subsidiary. This prediction is tested with data for 425 subsidiaries. The key findings were: (a) the extent for knowledge inflows differs significantly across all subsidiary roles; (c) it diminishes in a anti-clockwise direction starting in the high integration-high capability quadrant of the IC taxonomy; thus (b) both MNE integration and subsidiary capability drive knowledge inflows, although, the balance shifts more towards integration.

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