How to Boost Productivity

An economic review of policies to boost innovation and growth

Productivity is the units of output per worker, hour, unit of capital employed and others. While it is difficult to quantify, it is a concept that governments constantly monitor and strive to improve. One way of doing this is through aggregate demand management; another way is through fighting market power. The former increases business confidence but may prop up loss-making firms. The latter can incentivise new entrants into the market but could reduce the capital available for investment. These policies, if successful, have broader implications on equality and living standards.

AD Management

Aggregate demand management encourages firms to increase R&D and technology spending while shifting resources from less dynamic companies to more dynamic companies. It does this by increasing confidence within businesses. While this can accelerate long term productivity gains, it faces a trade-off with inflation as it risks overheating an economy. $10.4 trillion of global stimulus employed during the pandemic may prop up demand, but it has led to overshooting inflation targets. Additionally, aggregate demand management is likely to be achieved through lower taxation or increased spending, which increases the budget deficit. However, IMF reports imply that steeper tax rates should not discourage investments, and much of the current inflationary pressures arise from supply chain disruptions. Hence, aggregate demand management is an effective tool to increase productivity, which, if successful, is likely to reduce inflationary pressures.

Fighting Market Power

Fighting market power helps increase productivity by increasing competition, which encourages new firms to enter the market by innovating. This has been demonstrated by Tesla and Uber, who have gained significant market shares through lucrative business models. However, reducing monopoly power may reduce overall investments in R&D and technology. Firms often make supernormal profits in a monopoly, since AR>AC, whereas in a long-run perfectly competitive market, firms are price-takers and can therefore only make normal profits. Although this is a stark comparison, it demonstrates less capital available for investment when market power is reduced. Hence, fighting market power is an ineffective way of increasing productivity. Instead, a more efficient strategy is to encourage firms to invest their supernormal profits productively through tax exemptions and taxation on share buybacks.

Inequality

Accepting monopoly power as a driver of productivity can affect inequality. Firms can charge higher prices while enduring lower costs due to lack of competition, brand loyalty, and vertical integration. This can lead to excessive cash flows while increasing the cost of living, which has regressive effects on the poor. Additionally, if attempts to prevent share buybacks or higher dividend payments are unsuccessful, then this could lead to an accumulation of capital at the top of the wealth hierarchy. On the other hand, if governments can successfully enforce regulation to encourage investment back into the economy, then the opposite could be observed: lower prices and increased economic activity. This would increase employment and reduce the cost-of-living, uplifting poor households. Hence, while the acceptance of market power risks skewed capital accumulation, it can benefit many if managed well.

Living Standards

Living standards are affected by aggregate demand management. Due to rosier economic outlooks, the increased investment may increase the quality of infrastructure and products sold in the economy. Additionally, the productivity gains resulting from such investments mean that workers have two options: work fewer hours at the same output or the same/more hours at a higher output. It seems that the US has predominantly taken the latter approach over the last century, while Europe cherishes more leisure time. This could be a contributor to the growth of the US economy compared to the stagnating Europe. Despite different approaches to the use of productivity gains, USA’s living standards are not noticeably above Europe’s. Additionally, public investment plays a significant role in living standards improvements through the provision of public goods and social capital. Hence, while aggregate demand management may improve the quality of goods, the effects on infrastructure primarily lie to the government.

To conclude, aggregate demand poses a solid policy to increase productivity, benefiting from eradicating the problem it creates, inflation. Fighting monopoly power is inefficient, and it reduces the capital available for investment. However, it may widen inequality as prices rise and wealthy shareholders benefit greatly. AD management is likely to improve infrastructure for the private sector, but this is unlikely to trickle down into benefits for the people. The government may play a more significant role in promoting higher living standards.

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Ted Jeffery