Global Productivity: Trends, Drivers and Policies

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Thursday, July 16 , 2020 / 12:46 PM / by World Bank Group / Header Image Credit: World Bank Group/Ecographics

 

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Motivation

The COVID-19 pandemic has plunged the global economy into its deepest recession since the Second World War. Per capita incomes are expected to decline in about 90 percent of countries in 2020, the largest fraction in recorded economic history, and many millions will be tipped into poverty (World Bank 2020a). The pandemic is also likely to leave lasting scars through multiple channels, including lower investment, erosion of human capital because of unemployment and loss of schooling, and a possible retreat from global trade and supply linkages. These effects may lower productivity and limit the ability of economies to generate growth of real incomes in the long-term.

 

The likely adverse impact of the pandemic on productivity would be a worrisome outcome, as growth of labor productivity is the main source of lasting per capita income growth, which in turn is the primary driver of poverty reduction. Most cross-country differences in per capita incomes have been attributed to differences in labor productivity.1 Whereas the one fourth of emerging market and developing economies (EMDEs) with the fastest labor productivity growth during 1981-2015 reduced their extreme poverty rates by an average of more than 1 percentage point per year, poverty rates rose in EMDEs with labor productivity growth in the lowest quartile (Figure 1).

 

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The pandemic struck the global economy after a decade that witnessed a broad-based decline in productivity growth. The productivity slowdown, prior to the pandemic, affected around 70 percent of advanced economies and EMDEs. In advanced economies, the prolonged deceleration in productivity growth before the pandemic sparked an intense debate on how it would evolve in the future.2 Some innovations that had held the promise of considerable productivity gains, including digital technologies and automation of production processes, seemed to have been disappointing in this regard.

 

Meanwhile, EMDEs experienced the steepest, longest, and most synchronized productivity slowdown over recent decades. In these economies, decelerating productivity growth has put at risk hard-won gains in terms of catch-up with advanced economies achieved prior to the 2007-09 global financial crisis (GFC). Labor productivity gaps with advanced economies remain substantial, with workers in the average EMDE producing less than one-fifth of the output of those in advanced economies.

 

Against this backdrop, this book presents the first comprehensive study of the evolution and drivers of productivity growth and policy options to rekindle it. It makes several contributions to a large literature.

 

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Comprehensive Assessment. The book examines a wide range of topics that the literature has typically analyzed in isolated studies for smaller groups of countries: trends and prospects for productivity growth; global, regional, domestic and sectoral drivers of productivity, including factor reallocation and technological change; the effects of natural disasters and economic disruptions on productivity; and international productivity convergence.

 

EMDE Emphasis. The literature focuses largely on productivity developments in groups of countries, such as advanced economies or OECD countries, or in specific economies or regions. This book is the first to provide both an overarching global view of productivity developments as well as an in-depth view of productivity in EMDEs, including extensive regional analysis. It uses a comprehensive dataset that provides several measures of productivity growth for up to 35 advanced economies and 129 EMDEs, including 24 low-income countries, for 1981-2018. A new, comprehensive sectoral database for 103 economies allows a detailed analysis of sectoral productivity developments in six EMDE regions.

 

Analysis of the Implications of COVID-19. In analyzing the likely implications of COVID-19 for productivity, the book discusses the critical role of human capital accumulation, investment, and global integration in sustaining productivity growth- and documents how these factors were weakening already before the pandemic struck. It sheds light on the effects of COVID-19 on productivity by examining severe disasters (including epidemics, climate disasters, and wars) since 1960. While the current pandemic constitutes a truly exceptional shock, the book documents that even relatively milder health crises, such as past epidemics, were followed by lasting investment and labor productivity losses. The book also recognizes the possibility that the pandemic could unleash a boost to productivity and discusses the need for complementary policies to enhance potential productivity gains. Although the gains from such a boost may be unequally distributed, policy interventions can mitigate such unintended distributional consequences.

 

Multiple Approaches. The book synthesizes findings from macroeconomic, sectoral, and firm-level data on productivity. Previous studies have typically focused on only one of these three dimensions. It combines these dimensions with a comprehensive review of the literature in each area and state-of-the-art empirical methodologies that have in most cases previously been applied only to advanced economies.

 

Throughout the book, unless otherwise indicated, productivity refers to real GDP per worker. To ensure as large and comparable a sample as possible over time and across countries, this book uses the number of people employed rather than the number of hours worked as the measure of labor input. A second measure, total factor productivity (TFP), is also examined. TFP measures the efficiency with which factor inputs are combined; in "growth accounting" exercises, estimates of TFP growth are often used to proxy the rate of technological progress.

 

Key Findings and Policy Messages

Using multiple data sets assembled expressly for this study, the book examines trends in productivity growth since the 1980s. The analysis shows that productivity growth has become more synchronized, with steeper declines and shallower recoveries, and that cyclical factors have played a large role in driving these trends. The study of crosscountry sectoral data establishes that the slowdown in productivity growth after the 2007-09 global financial crisis has partly reflected fading reallocation gains due to the increased role of employment in some services sectors, where productivity tends to be lower than in the industrial sector. It concludes that labor productivity growth has been driven by innovation, better education, and investment in physical capital. It also finds that adverse shocks-such as natural disasters, epidemics, wars, and financial crises- have weakened productivity growth.

 

A recurring theme of the book is the long-standing and broad-based nature of the productivity growth slowdown that began before the COVID-19 pandemic. This highlights that any policy package to rekindle productivity growth needs to be similarly broad-based. A comprehensive approach is needed to facilitate investment in physical and human capital; encourage reallocation of resources toward more productive sectors and enterprises; foster firm capabilities to reinvigorate technology adoption and innovation; and promote an inclusive, sustainable, and growth-friendly macroeconomic and institutional environment. Within this comprehensive approach, specific policy priorities will depend on country circumstances.

 

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A Decade of Slowing Productivity Growth

Prior to the outbreak of the COVID-19 pandemic, the global economy featured a broad-based decline in productivity growth. Global labor productivity growth slowed from its peak of 2.8 percent in 2007, just before the global financial crisis, to a postcrisis trough of 1.4 percent in 2016 and remained below 2 percent a year in 2017-18 (Figure 1). The post-crisis slowdown was widespread, affecting around 70 percent of advanced economies and EMDEs and countries including over 80 percent of the global extreme poor, and affected all EMDE regions. In EMDEs, which have a history of recurring multi-year productivity growth surges and setbacks, the productivity growth deceleration from peak (6.6 percent in 2007) to trough (3.1 percent in 2015) was the steepest, longest, and most synchronized in recent decades. Labor productivity in low income countries was just 2 percent of the advanced-economy average over 2010-2018.

 

Estimates of the sources of labor productivity growth, based on the growth-accounting decomposition framework, suggest that the slowdown stemmed from both weaker investment and a deceleration in TFP growth, in approximately equal measures (Chapter 1). Up to half of the labor productivity growth decline in advanced economies and EMDEs over 2013-18 reflected lasting trends beyond cyclical factors.

 

As a result of the slide in productivity growth during the post-GFC period, the pace of catch-up to advanced-economy productivity levels slowed in ECA, and productivity fell further behind advanced-economy levels in Latin America and the Caribbean (LAC), the Middle East and North Africa (MNA), and Sub-Saharan Africa (SSA). In the regions that suffered the steepest slowdowns in productivity convergence, Europe and Central Asia (ECA) and SSA, they were affected by slowing investment growth, financial market disruptions, and a major commodity price slide.

 

Many Sources of the Slowdown

Over the past decade, the global economy has been buffeted by a series of shocks that undermined productivity growth, of which COVID-19 is only the latest. These shocks have compounded the erosion caused by an undercurrent of weakening fundamental drivers of productivity growth, associated with slowing progress achieved in convergence toward advanced-economy productivity levels.

 

Weakening fundamental drivers of productivity growth

Since the global financial crisis, improvements in many key correlates of productivity growth have slowed or gone into reverse. Working-age population growth has decelerated, educational attainment has stabilized, and the pace of expansion into more diverse and complex forms of production has lost momentum as the growth of global value chains stalled (Chapter 2). A new finding is the increasing importance over time of economic complexity, urbanization, and innovation, as well as demographic factors, and that many drivers of productivity have been stabilizing or declining over time. In addition, technology-driven gains in productivity have tended to displace workers in the short run. The COVID-19 pandemic and associated severe recession have increased the risk of further slowing in the pace of improvements in the long-term correlates of productivity growth.

 

A major feature of the current global recession has been the collapse of global trade, at more than twice the rate of decline in global output in 2020. This may be followed by an extended period of weak trade growth, particularly if concerns about the reliability of global supply chains lead countries to retreat from them. This would be particularly damaging to productivity growth prospects in EMDEs, where integration into global value chains has served to boost technological innovation and more effective management processes, and where export-oriented firms are usually the most productive. EMDEs would lose a critical engine of productivity growth if the loss of momentum of global trade growth were sustained.

 

Slowing reallocation within and between sectors

At the sectoral level, labor reallocation toward higher-productivity sectors has historically accounted for about two-fifths of overall productivity growth in EMDEs. This mechanism of structural change has also weakened since the global financial crisis. Fading productivity gains from labor reallocation have accounted for about one-third of the post-crisis productivity slowdown in EMDEs (Chapter 7). The COVID-19 pandemic may further compound this trend. Health crises, such as epidemics and pandemics, restrict the mobility of people, which slows geographical and sectoral labor reallocation.

 

Adverse shocks to productivity growth

Natural disasters, wars, and major economic disruptions such as financial crises and deep recessions tend to be accompanied by a large and protracted decline in labor productivity. Natural disasters-70 percent of which are climate-related-account for the vast majority of these adverse events. The number of natural disasters in 2000-18 was nearly double that of the preceding two decades. Health crises, such as pandemics and epidemics, have occurred less frequently than climate disasters-during 2000-18, the world experienced four major epidemics in addition to the swine flu (2009-10) pandemic: SARS (2002-03), MERS (2012), Ebola (2014-15), and Zika (2015-16). Nonetheless, these epidemics left lasting scars on labor productivity and output by 4 percent cumulatively after three years, mainly through their adverse effects on investment due to elevated uncertainty. (Chapter 3).

 

The COVID-19 pandemic has hit the global economy at a time of heightened vulnerability, with debt at record highs (Kose et al. 2020). This may further aggravate the productivity losses from the pandemic. In general, the long-term productivity losses associated with adverse shocks have tended to be larger and more protracted in economies with larger debt vulnerabilities (Chapters 3 and 6). This may have reflected highly indebted economies' constraints in supporting demand and activity through fiscal and monetary policies.

 

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Implications of COVID-19 for Productivity

As noted above, there are multiple channels through which COVID-19 could have a negative impact on productivity.

 

  • Weaker investment and trade. Uncertainty about the duration of the pandemic, and the global economic landscape that eventually emerges from it, may discourage investment (Bloom 2014). Concerns about long-term viability and resilience of operations may lead to a retreat from global value chains-which would choke off an important channel for international technology transmission-and discourage foreign investment that is often related to such production processes (World Bank 2019). Investment and trade play important roles in promoting productivity growth (Chapter 2).

  • Erosion of human capital and shifts in labor markets. Steep income losses and disruptions to schooling, which have affected more than 90 percent of the world's children, could increase dropout rates and set back human capital accumulation for a generation of children (World Bank 2020b). Education remains a critical driver of productivity growth (Chapter 2).

  • Slowing momentum in labor reallocation. Since 1995, the reallocation of labor from low-productivity to higher-productivity sectors has accounted for about two-fifths of overall productivity growth in EMDEs (Chapter 7). Mobility restrictions may slow the reallocation of workers away from low-productivity firms and sectors to higher-productivity ones, which often involves relocation from rural to urban areas (di Mauro and Syverson 2020). Pandemic-induced job losses may fall disproportionately on those previously employed in lower-paying services and informal sector jobs, possibly widening income inequality and eroding human capital.

  • Heavy debt burden. Governments and corporations entered the COVID-19 pandemic with already-stretched debt burdens (Kose et al. 2020). Corporate balance sheets may eventually buckle in COVID-19-induced recessions, straining bank balance sheets to an extent that could trigger financial crises. This would lead to obsolescence of capital as well as large losses of employment (World Bank 2020c). Lasting productivity losses from financial crises are well-documented and confirmed in new event studies in Chapter 3.

  • Yet, the pandemic may also create offsetting productivity-enhancing opportunities—for those countries that employ complementary policies to seize them. While major natural disasters, wars, and financial crises were typically associated with lasting productivity losses, major recessions sometimes encouraged the adoption of new technologies in certain sectors. COVID-19 could accelerate the automation of production, particularly in manufacturing, as well as the incorporation of digital technologies more broadly. These productivity gains may be unevenly distributed, causing employment losses in some sectors (Chapter 6).

  • Organizational and technological changes. The COVID-19 pandemic may trigger lasting organizational and technological changes to the way businesses operate if the pandemic becomes a source of "cleansing" effects that eliminate the least efficient firms and encourages the adoption of more efficient production technologies (Barrero, Bloom, and Davis 2020; Caballero and Hammour 1994; Foster, Grim, and Haltiwanger 2016).

  • Diverse and resilient supply chains. Supply chains may be restructured in ways that increase their diversity and improve resilience. In countries with strong or credibly improving business climates and governance, this could be a new opportunity to join global value chains that promote trade, foreign direct investment, and knowledge transfer and ultimately support productivity growth (World Bank 2019).

  • Improvements in education. Where reliable and widespread internet access exists but education systems are weak, the pandemic could improve utilization of higher quality online schooling and training.

  • Financial development. Digital technologies tested in the pandemic may expand access to finance in the poorest countries, enable more effective government service delivery and accelerate the trend toward the automation of some routine occupations.7

 

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