Labour productivity

(essay)

Abstract

The analysis in this paper dismisses the notion of a genuine trade-off between employment and productivity growth. Obviously, misguided policies to exploit such a trade-off have to be avoided. However, there are no reasons to think that structural labour market reforms boosting employment will typically entail negative implications for longer-term productivity growth. The dynamic response of productivity to positive labour supply and wage shocks may entail a temporary reduction in productivity growth rates, which, in principle could be considered as benign; anyway, the size of a negative effect of this type is estimated to be fairly small. In particular, this paper reaches the following conclusions: (i) The increase in employment since the mid 90s has indeed been to a significant extent the result of such positive labour market shocks, with about one half of the additional jobs attributed to structural improvements; (ii) Positive employment shocks can only account for a very small fraction of the observed productivity slowdown; consequently, the decline of labour productivity growth must be considered as predominantly caused by other factors and probably not just a temporary phenomenon.

1. Introduction

The so-called Lisbon strategy involves efforts on several fronts both to improve labour market performance and to raise productivity growth in the EU. This twin aspiration is neatly summed up in the phrase ‘more and better jobs’, which implies higher employment rates but also more productive, higher-quality employment.

The strategy sets explicit targets for ‘more jobs’: an employment rate of as close as possible to 70% and a female employment rate of over 60% by 2010. The Stockholm summit a year later added a further target of an employment rate of 50% for older working-age people. Given the rate of employment growth required to meet these targets, the Lisbon conclusions also established an implicit target for productivity growth with the statement that – if the recommended measures were implemented against a sound macroeconomic background – it should be possible to achieve 3% GDP growth.

These targets have met with criticism in some quarters on several counts. Some regarded them as over-ambitious, particularly since the European Council (as opposed to individual Member States) lacks full control of the necessary instruments to meet its objectives. There were doubts about whether a credible strategy had been set out, or even whether EU leaders realised the extent of the reforms that would be required. Others pointed to the risk of policy distortions – there are many ways to raise employment rates, for example, but not all of them are fully consistent with raising economic welfare. On the other hand, the Lisbon targets appeared to score an initial public relations success, being widely interpreted as a signal that the EU was taking economic reform seriously. (Even then, however, it was noted that this might damage the credibility of similar exercises were the targets to be missed by a wide margin.)

Two clear advantages of the Lisbon strategy, and especially the employment rate targets, are often overlooked in these discussions. First, the commitment to raising employment rates (i.e. raising labour force participation as well as reducing unemployment) represents a clear rejection of an idea that has been one of the great weaknesses of European employment policy in recent decades, namely that high unemployment can be cured by discouraging labour supply. If this seems obvious today, it is not so long ago in some countries that married women were discouraged from working, while older workers were actively encouraged to quit the labour market through early retirement schemes, partly in response to high unemployment. Even more recently, governments in some EU Member States were entertaining a similar notion – that employment in persons might be boosted by means of regulatory restrictions on hours worked.

Secondly, the Lisbon strategy embodies the idea that structural improvements in the functioning of markets are required for a sustained increase in employment rates and higher productivity growth. Clearly, at any given moment, output and (un-)employment are determined by real demand in the economy. However, over the longer term, real demand will generally tend towards a level consistent with stable inflation, this level being determined by overall supply conditions in the economy. By focusing on the functioning of labour, product and capital markets, as well as investments in R&D and human capital, the Lisbon strategy seeks to raise employment and growth potential in a sustainable manner.

In addition, while one may ask whether the employment rate is the ideal variable to target, there is no doubt that low employment rates in several EU Member States are a symptom of poor labour market performance, and that improving labour market performance would lead both to higher employment rates and to greater economic welfare. The benefits of higher employment rates for the sustainability of the public finances (at least in the short-to-medium term) were also noted.

Against this background, this paper focuses on a crucial question for the strategy of ‘more and better jobs’: whether and in what sense there are trade-offs between employment growth and productivity growth. Concern has been raised in some quarters that raising the employment rate in the EU will result in lower productivity growth. Indeed, there is a grain of truth in this: a rising employment rate implies that productivity growth will be temporarily below full potential, simply because the number of workers per unit of capital is increasing. ............