Tracking The Gains From Productivity

Where does the money go?

Written by Stephen Poloz

It is widely agreed that increasing productivity is a good thing. It makes companies more competitive, helps them increase their sales, and makes employment more secure. It also brings more money into the company. But where does the money usually go?

There are several examples worth examining. In the U.S. and Japan, productivity growth is running at over 3%, which is very strong. In Germany, the latest figure is a more modest 1.4%, which is still solid, and an upturn appears to be emerging. The latest figure for Canada is 1.3%, but for the manufacturing sector we are running at more than 4% productivity growth. All the signs point to a broader productivity upturn ahead, as the economy is operating at roughly full capacity.

When productivity rises, it is most likely to show up in the form of lower costs for the same output. There is more value in the operation, and there are three possible channels for the money.

The first money channel is to reward the company’s workers. This is not happening so far in Germany or in Japan, where wages are rising at only 0.4%. In the U.S. and Canada, in contrast, wages are rising at rates of 3.1% and 4.0%, respectively. In Canada’s case, a pickup in wage growth in the manufacturing sector could be related to stronger productivity, but there are also tight labour conditions in some sectors, such as construction, for example.

The second money channel is to allow the higher productivity to pass through to the company’s bottom line. This, too, appears to be happening. Profits are up 11% in Japan, 12% in Canada, more than 15% in German and a whopping 37% in the U.S. These are all very high numbers that foreshadow even more investment in productivity-enhancing capacity ahead.

The third money channel is to reward the company’s customers by offering their products at lower prices. Indeed, in a highly competitive environment such as the present one this is the most likely final outcome. This is because the company’s competitors are probably increasing productivity, too, and they have an incentive to undercut the market to expand their market share. This competition tends to force most of the benefits of productivity growth out into the marketplace in the form of lower prices. And, it so happens that inflation in the major economies is very subdued, excluding energy effects, which suggests that this channel is indeed active at present.

Regardless of what companies do first, eventually the money ends up back in the economy. Higher profits finance new investments, higher wages finance new consumer spending, and lower prices boost competitiveness, exports and real purchasing power. The good news for central banks is that the stimulative effects of higher productivity are accompanied by the tendency for competition to produce lower prices, a combination that helps to keep inflation pressures at bay.

The bottom line? Higher productivity growth in the major economies is showing up in all the usual places, with the pattern varying from one place to another. But what they all have in common is a rising living standard and continued low inflation — not a bad outcome.

January 19, 2006

The views expressed here are those of the author, and not necessarily of Export Development Canada.

Originally appeared on PROFITguide.com