Friday, October 31, 2008

Why Productivity Growth Is So Important?

Despite UK economic growth is enviable by its major rivals such as France, Germany & US, there is still one area where UK consistently lagged behind them. That is non-other than low productivity

Definition: Productivity is output per worker

Why productivity growth is important?

(1) Determines standard of living
. If productivity is significantly increased, it will cause a large rightward shift in AS curve. By that time, UK economy can generate more output & more income per worker. This acts to increase standard of living on 2 bases. First, UK people get to consume more goods. Second, increase in income can help to reduce poverty & income inequality

(2) Lower inflation. If productivity growth is impressive, on average each worker can produce more & this helps to lower down the cost per unit of output. This is because the total costs (fixed costs + variable costs) are spread over a larger range of output. Businesses will be able to pass on these in the form of lower price to consumers. This will also help to ease cost-push inflation

(3) Attraction to foreign MNC
. MNC here means multinational companies. These large firms often consider large variation of factors before deciding to invest in a country. Normally factors they look at are productivity of workers or we can say costs per unit of labor, level of education, facilities, and government regulations on MNCs etc. If UK is competitive on this, it may be able to at least compete with low cost Asian economies such as China, India, Malaysia & Vietnam to attract investors

(4) Narrowing the deficit on BOP. Balance of Payments is an account that summarise the transactions between UK & the rest of the world. By experiencing high productivity growth thus driving down the costs per unit of good, UK will be more competitive in terms of international pricing. Demand for UK exported goods will grow over time, especially from its major trading partners like US, France, Germany, Netherlands & Italy as it could be relatively much cheaper than buying elsewhere. Although this will not solve the large deficit in BOP which is mainly due to trade in goods, it will at least narrow it

Counter arguments

(1) How to measure productivity? Some economists argue that it could be quite a tricky task in measuring productivity of workers as it has a lot to do psychological behaviour in work place. Also, productivity could be easier to measure if we consider manufacturing industry where workers deal with machineries, but how about in services sector which varies in nature like banking, teaching, hotel etc? Therefore the usage of real GDP per capita & HDI (Human Development Index, which we will learn next term) is a more appropriate measure in determining standard of living

(2) Inflation may not be lowered
. It could be too early to say that higher productivity will necessarily lead to lower inflation. Inflation is driven by many other factors. If there is a cut in interest rates it will cause UK people to remortgage their property or a phenomenon which is called as mortgage equity withdrawal. This causes an increase in consumption (C) which will drive up AD. Business will expand their operation. Governments may increase their spending on healthcare, education, infrastructures, social services which they always do. These combined can possibly caused an upward pressure in inflation. Also we need to consider external shock such as high oil price which once reached $147 per barrel in July

(3) Not sufficient to attract foreign investors. The main argument is that, costs per labour in developing Asian economies like Vietnam & China are far much cheaper than UK. I personally don’t think that UK will be able to do so even when abolishing the National Minimum Wage. Compared to China, UK has stronger labour laws & also their workers are more represented by labour unions. In China, working conditions are bad & most of the time the employees are less educated & not aware of their basic rights. These enable the employers to exploit them by paying low salary which overall lead to lower costs of production. Large MNCs will definitely be attracted to China given that labour costs are large % of total production costs

(4) BOP may not narrow. Pound has appreciated against many other major currencies since 1996. This means Britons have large purchasing power & it is cheap for them to buy from any other countries. The people in UK has large marginal propensity to import & that is they have tendency to spend large proportion of their income on imported goods. This explains why the trade deficit in goods has widened over the years even though UK began to close down the productivity gap with its major rivals

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