Global economy’s dilemma – the innovation paradox

WHAT’S happening?

Today, more persons in the US than ever are pushing the frontiers of science and technology – share of US workforce in science and engineering jobs rose from 1.5% in 1960 to above 4% today; and intellectual property is piling up – US patent grants are at an all-time high; yet, productivity growth is slipping – from a high of 3.4% annual rise in total factor productivity (TFP) in the 1950s to less than 0.3% today.

The same is happening to most of Asia, including Malaysia (TFP growth = 0.1% in 2011-15), while some others are doing better: Vietnam +1.4%; Indonesia +1.2% and China and India, +1% each. Economies grow by equipping a rising workforce with more capital, then combining capital and labour creatively to raise TFP, which captures the contribution of innovation.

Over the past 60 years, outside of personal technology, improvements in the quality of life have been generally incremental, not revolutionary. Sure, airplanes are bigger and can now fly faster, and corporate communications move ever more efficiently. But none of the 20 most prescribed drugs came into the market in the past decade.

What happened? Despite all the resources invested in innovation, dwindling gains in science, medicine and technology are holding back economic growth, not just in the US but throughout the Organisation for Economic Co-operation and Development (OECD) rich nations.

Breakthroughs

To be fair, there has been significant innovative technological breakthroughs in: energy (including alternative energy sources like solar and wind, smart electric grids); biochemical-medical (genetics and stem cell, including use of big data to reduce costs in healthcare and allowing people to live healthier and longer); information (including the Internet of Things, Web 2.0/3.0, cloud computing and virtual reality); manufacturing (robotics, 3-D printing, automation); financial (new apps that revolutionise payments to lending); and defence (including drones and advanced weapon systems).

Yet, why is it that there is such meagre measured productivity growth?

By one estimate, had US productivity growth not slowed, GDP would be about US$3 trillion higher than it is today. There is this pos- sibility that there is a vicious circle between rising inequality and lowering productivity.

There is already a growing divide between “frontier” businesses and the rest of the economy, with some regions and workers left behind in a low-skill, low productivity trap. It would seem that while US great technology enterprises have changed the way we live and generated vast wealth for some, they have not triggered a widespread improvement in productivity or household incomes.

Growth and productivity

Economic growth stems from putting more people to work and getting them to work smart (thereby raising productivity). As population ages and the workforce stagnate or even decline in the next two decades, the future rests on getting productivity up. OECD data on GDP per hour worked is cause for severe disappointment. Growth is well below its level in the late 20th century. The brief surge seen in US, Canada, Ireland and South Korea at the turn of the 21st century has dissipated.

For most advanced nations, productivity currently rose at below 0.5% annually. Globally, GDP per worker (an alternative measure of labour productivity) rose just 1.2% in 2015 (1.9% in 2014). In Malaysia, it’s 3.4% in 2015 (3.7% in 2014). The slowdown in China was a major contributing factor, as were Latin American and African nations because of weaker oil prices.

GDP per hour worked in eurozone grew by 0.5% in 2015 (0.4% in Japan and -0.2% in US). Together with a shrinking workforce, GDP growth can be expected at best to be sluggish in the years ahead. The role of technology lies at the heart of the puzzle.

Forces at play

Economists can’t agree on the real cause behind the productivity puzzle. Many forces are at play. Prof Robert Gordon contends that the digital technology boom just isn’t all it’s been cracked up to be. Indeed, it pales in comparison with the great innovations of the first and second industrial revolutions (steam engine, electricity, telephone, anti-microbial drugs, etc.) Second, there are those who think that the data is defective.

GDP does not fully capture the transformative advances in information technology, fintech and the medical biosciences. Current data is too focused on the production of physical goods and traditional services, missing the hard-to-count benefits (many being “free” like on the internet) of the digital revolution. Indeed, between search engines and ubiquitous apps, knowledge is at our finger tips nearly always, making everyday living so much easier, more productive and more fun. So the mis-measure of productivity growth can be serious.

Then, there is always the time lag between innovation and its full impact on productivity. The growth dividends from disruptive technology require much time (often decades) before they are widely diffused and used.

Studies showed that the productivity boost spurred by the transformative innovations of early 20th century took decades to kick in. Fourth, the possibility that potential GDP and productivity have fallen since the 2008 financial crisis because of aging demographic factors, which combined with low fixed capital investments have led to the emergence of “secular stagnation,” as postulated by Harvard’s Larry Summers.

All these can be rather confusing. So much so, some economists have even pointed to the onset of hysteresis – a persistent cyclical downturn or weak recovery (like US jobless recovery) leading to permanently lower productivity growth. The hard reality is that we don’t know for sure what’s driving the productivity puzzle. What is certain is that if this trend persists – and with it, sub-par growth in wages and living standards, the current populist backlash towards growing protectionism and nationalism will gather strength to the detriment of free-trade, market-oriented policies, and social and political stability.

Services – a drag

Often overlooked in the debate is how hard it is to innovate in services. US households spend US$8.3 trillion on services in 2015, more than double their spending on goods. In China today, the services sector surpassed 50% of GDP for the first time. To set the perspective: share of US workers in more-productive manufacturing has shrivelled from 13% to 8% of the total since 2000; while workers in the fast growing health, education and food-and-beverage services swelled from 17% to 23%. Here’s the drag: average annual productivity growth in these 3 sectors (from hospitals to the corner bar) ranged from -0.6% to 0% in 2004- 14. Ironically, society wants their hairdressers and therapists as well as financial advisors and lawyers to take their time – often the definition of good service.

Hence, Prof William Baumol’s lament of the “cost disease,” where rising wages in the arts in particular are not matched by rising productivity: performing Schubert’s concerto took the same time and the same number of musicians in the 21st century as it did in the 20th. Here, rising cost and stagnant productivity co-exist. This explains the difference between measured productivity growth of 1.6% in manufacturing and 0.2% in services in the OECD nations between 1970-2005.

What then, are we to do

Slowing output per hour is worrying but poorly understood. As an economist, I know of few problems that are so important and yet command so little consensus about their source and solution as the persistent slide in productivity growth across the world’s economies: rich, emerging and poor. At this time last year, the Conference Board (US private think-tank) reported that labour productivity – measured as output per hour worked, fell in the US for the first time in more than three decades (following a decade of slowdown). Across OECD and emerging nations, productivity has been slowing for more than 40 years. So much so, Fed chairperson Yellen pointed to the US being engaged in a productivity crisis.

The implications are stark. Productivity is the ultimate test of our ability to create wealth. In the short-run, productivity can be raised through working longer hours, importing people, raising retirement age, even bringing-in more females into the workforce. But these options will soon lose steam.

Unless we work smarter, growth will exhaust itself. As Prof Paul Krugman puts it: in the long-run, productivity is everything. Unfortunately, slowing productivity is a complex problem with no obvious solutions. It needs urgent and sustained attention. President Trump’s focus on “America First” but ignores global climate change, makes driving domestic production towards higher efficiency a difficult challenge.

Realistically, when governments try to improve productivity the Schumpeter way through creative disruption, whereby innovative ways displace stodgy ones (such as French attempts at labour market reforms), they face widespread resistance. This simply suggests that the problem is not going to go away anytime soon.

Obiter dictum: Jobs and mood on the streets

Today more people have jobs in OECD’s 35 developed nations than before the financial crisis hit in 2008, and employment will rise further in 2018. European unemployment remains high. Still, there is discontent on the streets with the way the economic union works and how the benefits of growth are distributed. Data on employment and unemployment are at best, flat.

This year, OECD came up with a scoreboard of labour market performance comprising nine indicators: three for quantity (employment: headcount and share of workforce in employment, and unemployment rate), three for quality (earnings, labour security and working environment), and three for inclusiveness (share of workforce at bottom half of median income, gender, and the disadvantaged share). Three observations from its June 2017 issue are worth noting: (1) a strong negative correlation exist between low-income and employment rates – high employment has fewer employed with low incomes; indeed, jobs can cure poverty.

It’s noteworthy also that US has Finnish high levels of employment but Greek levels of low income. The low income rate in US is almost 12%, as against 7% for OECD as a whole. US politicians should be worried; (2) there is a strong positive correlation between high employment and decent jobs. UK and Japan rank high on employment rates; although Japanese workers feel relatively more secure, they are also more stressed; and (3) high employment often co-exists with decent and inclusive jobs, e.g. Scandinavia and Iceland rank among the highest on employment rates, with good rankings on other metrics as well. OECD’s three-dimensional presentation of labour markets offer useful analytical insights for policy making.

Asians should emulate.

Former banker, Harvard educated economist and British Chartered Scientist, Tan Sri Lin See-Yan is the author of ‘The Global Economy in Turbulent Times’ (Wiley, 2015). Feedback is most welcome; email: starbiz@thestar.com.my