Conceptual Tool #7: Productivity
A simple model: Three people are catching fish using their hands. It is hard work, fish are slippery, and they work all day to catch just enough so that they are not not hungry. But then: they get spears they can use to catch fish faster. With a spear they can catch bit more--enough that two of them can produce enough food for all three people.
More is usually better, especially in economics. And this situation sounds good: more free time to frolic in the meadows, paint pictures, or raise the kids.
But it is not quite so simple. While a productivity increase may seem like an unadulterated good thing, there are plenty of ways productivity increases can fail to live up to their potential--or even make things worse. As I have been repeating in my last few posts, the relationship between production (productivity) and distribution (who gets the productivity) is a complicated one.
Economics as a discipline has a tendency to skirt around this complexity via the following logic: perfect markets have efficient outcomes, imperfect markets can be fixed, and any further distribution issues are political. It is certainly not true that economists are never interested in distribution, but there is a general tendency to assume that increases in efficiency and productivity will nevertheless be good for the general population. Or from a different angle, that good things cannot happen in an economy without increases in productivity. Besides, worrying about distribution smacks of Marx, and every economist knows that his labor theory of value was wrong.
I should mention also that distribution is not the only potential problem with changing productivity. If you have some time to burn this classic essay by Jared Diamond is a good example of why productivity can be a bad thing for many more reasons than just its distributional effects. A recent post at Naked Capitalism highlights some other reasons that productivity can be problematic, even disastrous, in more modern societies. Distribution is the primary issue I am focusing on in this series of posts, however, so I will not go into much detail regarding other implications of productivity.
Productivity, defined as output per person (or per person-hour) and illustrated in the fishing example above, is an important idea in modern economics. When economists or politicians talk about economic growth--and economic growth is generally assumed to be a fundamental prerequisite for a well-functioning and competitive economy--they mean increasing aggregate productivity. Productivity is important for individual businesses on the micro level as well, although they do not always view it in precisely these terms.
The fact that productivity is a ratio of two other things makes it a bit weird. Increasing productivity in an economy can result from two causes: either increasing output (the numerator) or decreasing workers (the denominator). Individual businesses typically think in terms of profit instead of productivity, but the connection is easy to see. Increasing profit comes from increased revenues or decreased costs; revenues are derived from the sales of output, and labor makes up a large portion of business costs. Instead of a ratio, profit is a defined using subtraction, but it can also be constructed as a ratio in various financial metrics.
In any case, if our economy assumes continued growth and relies on increasing productivity to fuel that growth, growth can come from either making more things, or making things with less people. If fishers start using spears, productivity will increase whether everyone keep fishing and catches enough fish for 4.5 people, or one of them stops fishing and two people catch enough fish for 3 people--in productivity terms, the amount is the same because it is being measured per person. This may seem trivial, but in fact it has important consequences.
We can apply the idea of scarcity to productivity increases. In the above model, in the beginning, the supply of fish exactly met the demand. When the fishers started using spears, though, it decreased the scarcity of fish by increasing supply.
How does this decreased scarcity affect distribution? Frankly, we do not have any idea. At this point the story could go almost anywhere, because we have not given enough background or fleshed out enough of the model.
Let's brainstorm what could happen. The three fishermen could simply work a third less. They could take turns fishing and get every third day off. One fisherman could sit around all day while the others fished. One fisherman could do other work. They could all keep fishing all day and save their extra fish, or trade them or even throw them away. They could all keep fishing and the biggest fisherman, or maybe the fisherman who invented spearing, could make the others give him their extra fish. They could fight about who gets to not fish. Two fishermen could gang up on the other one and make him fish all of his time while they split the remaining free time. Or the two fishers could keep fishing while making the third do worse work that benefited them, like gutting the fish. Their new more productive fishing techniques could deplete the fish stock leave everyone starving. Having extra fish to throw away could become a badge of honor and they could start fishing more and more until until they died of exhaustion.
Certainly many of these sound contrived. When one looks back at actual human history, though, the easy answer--that people will evenly divide the gains--appears just as contrived as the any other story. Just because a better outcome is possible, does that make a productivity increase an inherently good thing? Does it make sense to divorce the productivity increase from the new economic and social forces it unleashes?
It may be useful to use the brainstormed scenarios to suss out the forces, dynamics, and assumptions that contribute to different outcomes.
As we noted above, productivity can mean people working less or people making more things (or some combination of the two). These two options are easily seen in the scenario list: in most scenarios the fishermen are doing less fishing.
Whether they continue fishing even though they are producing more fish than they themselves currently demand depends on whether there is a demand for fish beyond their immediate need. This additional demand can come from the fishermen's own need in the future (if they can save the fish) or from other people that will trade for fish. It is also possible that their demand for fish could grow, if the fishermen started wanting fish for more than just eating--a new kind of demand for the same product.
In the scenarios where they stop fishing and increase productivity by decreasing the amount of people fishing, it is clear that the fishermen value other things more than the extra fish. "Other things" can be as simple as "doing things with your time that are not fishing", as complex as a house that productive fishermen built in that spare time, or as unfair as the foot massages massages they got from the newly subservient fisherman.
One thing that seems clear from the hypothesized scenarios is that productivity may create unfairness. If the fishermen must work all day, there is no excess wealth--neither time nor output--to hoard. But perhaps this is simply an artifact of how I constructed the thought experiment: is there really a time when people's production it could be argued that people have always profited from others because so rarely in recorded human history have we had to spend all our time on basic necessities. At the very least, profit is closely associated with commerce and is probably present in any society where there is specialization and trade.
But which is better? Three fishermen who must fish all day, or, say, two fishermen who fish and one who collects his fish as taxes or tribute? The typical economic answer would be the latter--the logic being that the economic situation has improved; the distribution problem is political.
Economics tends to wash its hands of distribution all too quickly. It is fond of statements like: “capital owners will benefit from opening trade barriers, while the outcome for labor is ambiguous but smaller than the benefit to capital owners. The most efficient solution will therefore be to liberalize trade and redistribute the gains.”
But society does not simply "decide" how to distribute gains from productivity: politics is not some alternate universe where economics does not apply. Decreasing labor's bargaining power in the economy may short-circuit their political power as well. Sometimes the processes determining distribution are best characterized as wholly political; but other times they have clear economic causes. Assuming a benevolent redistributive force is perhaps no less presumptuous than a benevolent distributive one (a.k.a. communism).
Instead of a simple net positive for society, productivity gains should be recognized for what they are--the restructuring of scarcity resulting in realignments of economic power. The new structure can be beneficial: it has improved our material lives beyond the wildest dreams of our ancestors and as a general historical trend, productivity has trickled down. But this should not be seen as an inevitable law: productivity gains in the USA in the past decades have gone almost entirely to capital owners and have been important drivers of the recent increase in inequality.
We can use several of the possible outcomes of the fishing scenario to flesh out occasions where power might come into play and ways for ensuring that productivity gains contribute to broad-based wealth increases. In the scenario where one fisherman owns the spears, the other fishermen are willing to pay the spear owner for their use. The spear owner is thus able to capture all of the gains from new technology. This is an example of economic power, and is less sensical in a state-of-nature example than it is in the real world, with our complex system of property rights.
In another scenario, the fishermen produce more because there is external demand for fish. This is a better outcome because they get stuff in exchange for the extra fish they catch. But if one fisherman does not have equal access to new technology, he may be unable to sell his fish as cheaply as the fishermen with better spears, and may have difficulty selling any at all. This is a passable explanation for much of the unemployment in developing countries, where workers have no way to be productive and are therefore unable to compete. Also, this example becomes more problematic in a specialized economy where workers are not producing for their own consumption at all—I will address this in depth in the next post.
The first way, then, to ensure productivity gains contribute to the general welfare is to ensure that new gains are not monopolized. Monopolization can depend on the accessibility of the market to new entrants, which facilitates competition that reduces the economic power of the initial producer. Our patent system, for example, grants temporary monopoly rights in exchange for making inventions public knowledge. In addition to laws, the technologies of production themselves can structure entry into a market: the airline industry requires advanced technology and expertise, for example. In markets with high barriers a monopoly is much more likely to form and a company is more likely to take advantage of their economic power by charging above cost for their product.
The second way to ensure that increasing productivity works for everyone is to ensure that scarcity remains in balance. A functioning economy relies on an intricate web of supply and demand in both product and labor markets. If scarcity is restructured in a way that eliminates demand for certain suppliers in the economy, the demand created by these suppliers will also be eliminated. In the fishing scenarios the fishermen are self sufficient whether or not they use a spear, but in our real economies today few people can simply go back to their farm. Instead, those laid off due to productivity increases may be unable to recapture a sufficient amount of scarcity. Even though the economy has more productive potential, output may decrease if there is no one to buy it.
Economists often make similar assumptions to ones we made about the fishermen, by assuming people choose not to work or there is always demand for other work. Such assumptions are not ridiculous: people do often choose not to work, and demand for work has increased or remained relatively steady despite continued advances in productivity over the past hundred years.
The question of whether demand will continue to emerge for new work--and whether it will emerge in a way that truly balances scarcity in an acceptable way--is beginning to make it back on to the radar of economists and policymakers. In the past new scarcity has arisen from the increasing complexity of our society: we need accountants, tech support specialists, and hundreds of other occupations that did not exist a hundred or even fifty years ago. Complexity can beget complexity, to a point. People also have a way of demanding silly things--often the exact things which are rare. These peculiarities of taste and new demand serve to even out the market a bit and create scarcity where no scarcity previously seemed to exist.
But these forces are not a guarantee that scarcity will continue to drive the economy forward. Even if it does, as we learned in the last post about elasticity, not all scarcity is created equal. As difficult as it is to anticipate where our productivity gains are taking us, we need to do more to understand how we are getting there. The tools of economics are limited but can be useful, if we are looking at the right things.