The future wealth of nations will be dependent both on improvements in productivity and in labor force participation

News categories: the New Economy Economics, enterprise and business strategy

A recent study of The Conference Board, a global, independent research organization, revealed, that the U.S. economy – despite the actual slowdown – is likely to outpace the rest of the world in the future in terms of productivity, economic growth and income.

Productivity acceleration in the United States that started around 1995 continued at the begin of the new century. Estimates suggest that U.S. productivity in 2000 rose 3.8 percent over the previous year. Productivity growth in most other major industrialized nations was relatively sluggish in contrast. For the European Union as a whole, productivity grew by 1.4 percent in 2000, and Japan experienced some improvement, at 2.3 percent.

But improved productivity growth in the U.S. is only one part of the story. The U.S. economy also further improved its capability to translate productivity improvements into higher per capita income: Compared on actual numbers, the European Union has productivity that is 82 percent of U.S. productivity, but its per capita income is only 69 percent of the U.S. level.

What enables the U.S. economy to turn productivity into higher levels of income ?

Translation of productivity into income depends on labour participation, that is on the proportion of the population that is involved in production. Since the 1970s, the United States has led most other countries in the OECD in translating productivity gains in to per capita income. In most countries in Europe the lower translation rate of productivity improvements into per capita income is due to a lower overall participation rate (the number of people involved in production of the gross domestic product/GDP compared with the total population).

There are various reasons why European countries have lower participation rates compared to the U.S.. In Norway and the Netherlands it is due to low average working hours. However, in most European countries, unemployment is playing a role, but the most important reason is a lower share of the labour force at working age (15-64). And this increased the income gap between the European Union and the United States by 10 percentage points. Europe has clearly a demographic disadvantage compared with the U.S..

Economic Growth Requires Efficiency and Work

The dramatic performance improvement in the U.S. economy compared to other industrialized economies, is due to success on two fronts:

- a rapid improvement in productivity, mainly through higher investments in technology-intensive industries – in particular, information and communication technologies

- a high level of labour force participation, mainly through more flexible labour markets and its demographic advantage, at least over European countries

The future wealth of a nation – if we assume that it is dependent on economy wide growth and per capita income – is therefore based on a countries capability to continue to achieve productivity improvements and to maintain growth in labour input.

What does this mean for Europe ?

1. Countries within the European Union have to be cautious, not to get onto a low-productivity growth track and to concentrate solely on reducing unemployment rates. Whereas in the first half of the 1990s (1990 – 1995) annual average labour productivity growth rate was still 2.4 percent, that rate dropped in the second half of the decade to 1.2 percent. That drop in productivity growth offset the slight rise in employment, so that GDP growth improved much less than it would have with productivity growth rates similar to those in the U.S.. Keeping in mind, that the rapid acceleration in U.S. productivity growth in the last half of the decade is closely tied to fast technological change and increased investments in new technologies, specifically into information and communication technologies, Europe has to stimulate that type of change too in order to become economically more successful. Because technological change does not just happen solely through increased investments but is dependent on changes in institutional, regulatory, and legal structures as well, European Countries have to accelerate the pace of reforming their old structures.

2. Countries within the European Union also have to master the challenge of an aging population which is seriously threatening their capabilities for future economic growth, income and wealth. Keeping in mind that labour force participation rate is an important driver for economic growth and wealth of a nation, Europe has to prepare its population to work more years and to accept immigration.

A recipe for Asia ?

Japan maintained a high level of productivity growth rate throughout the 1990s, despite several recessions, but it did so at the cost of employment growth. Whereas Japan does not stand for Asia in total, it can serve as a kind of “leading example”. So Countries in Asia probably will have to face also two major challenges in order to become economically more successful and increase their economic performance compared to the U.S.:

1. Improve productivity through investments into new technologies and structures. This requires more flexible product and capital markets that help to reallocate capital to its most productive use. But it also and especially requires major investments into education.

2. Get high rates of its fast growing population involved into the countries economic activities. This requires greater flexibility of labour markets.

The productivity, output and labour figures mentioned in this report can be obtained from a large database with annual figures for about 70 countries and for most countries since 1960. It is maintained by the Groningen Growth and Development Centre (GGDC) at the University of Groningen which is sponsored by The Conference Board.

More about this topic and other New Economy issues in my upcoming new book “Management in A New Economy: How to exploit intangible assets and create value in a new environment”.

More about about New Economy Economics and Management Best Practice in general, and about other related topics will be continued here in this new New Economy Analyst reports. To subscribe for Juergen Daum’s free-of-charge e-mail push newsletter click here.

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