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Roger Martin
September 14, 2015
I find it interesting to listen to economists talk about U.S. productivity
growth or the lack thereof. It has been a source of much fretting over the
years. The 3+%/year labor productivity growth rates of the 1950s and 1960s
slowed to under 2% in the 1970s and then to 1.5% in the 1980-1995 period. There
was a heartening rally between 1996 and 2004, when growth returned to its 1950s
/1960s levels of 3% a performance almost universally attributed to the
efficiency gains from information technology.
But just as the economists and IT enthusiasts were completing their victory
lap, productivity growth headed into the doldrums for a decade growing at an
anemic 1.4%/year from 2005-2014, with the slowdown starting well before the
global financial crisis. When the first quarter of 2015 revealed a 3.1% decline
on the back of a flat 2013 and +0.7% 2014, it precipitated much wailing and
gnashing of teeth. Thankfully, the just-released revisions to the second
quarter 2015 growth of 3.3% wiped out the first quarter decline and helped
economists breathe a collective sigh of relief that we aren t necessarily going
into a hell in a productivity hand basket.
As I read all the productivity analyses and commentary, including the recent
one on these pages by the clever folks at the OECD, I am struck that in trying
to understand productivity, economists exclusively look at only one half of the
productivity equation literally not figuratively. That impedes their ability
to understand what is really going on with productivity in the modern economy.
Most people instinctively think of productivity as a quotient: a physical
output (e.g., a ton of coal) divided by a physical input (e.g., labor hours).
They wouldn t be wrong; that is where productivity measurement started.
But to say something useful about the comparative productivity of different
kinds of enterprises, you can t compare the output one ton of coal with one
automobile to judge the one that used fewer labor hours to be more productive
. It is, of course, apples and oranges. To make the comparison you need to
convert the numerator from a physical measure to a financial one
conventionally the dollar value added (essentially a product s selling price
less purchased inputs), which is also how economists measure a country s Gross
Domestic Product. Once you have a dollar figure for the numerator you can
compare the productivity of labor across industries and jurisdictions in terms
of dollar value-added created per hour worked.
So far, so reasonable, but when figuring out how to improve productivity,
researchers almost always focus on the direct determinants of the denominator
they think about how to use technology, training, re-engineering of work
processes, and automation in order to reduce the number of labor hours required
to produce a given product or service.
The numerator is entirely ignored as if the value of the output was fixed and
immutable. However, as any student of strategy knows very well, the dollar
value-added that a firm generates is directly proportional to what it can
charge in the marketplace for its products or services. And that price is, in
turn, highly sensitive to the competitive dynamics of the firm s industry and
the strategic decisions it makes. Given the basic dynamics of a quotient,
changes to the numerator are equally important to results as changes to the
denominator.
An example of the impact of changes in competitive dynamics can be seen from
our experience with globalization. After China joined the WTO in 1997, the
effect of its exports on many U.S. markets was to systematically reduce
prevailing price levels. While ignored by economists, this has created massive
downwards pressure on U.S. labor productivity as Chinese exporting ramped up
after 2000. Many US firms in many U.S. industries had no chance to reduce their
denominator (labor hours) as fast as the market-driven numerator (prevailing
price levels) fell. While on a physical basis, many were reducing the labor
hours per unit (of whatever they were producing), their efforts were swamped by
the reduction in the value those units generated. That shows up in an
economy-wide reduction in the pace of productivity growth in the past decade.
That notwithstanding, there is little discussion among economists of the mixed
impact of globalization on US productivity growth numbers. Most consider
globalization an unalloyed good for productivity because it reduces
denominators. While it almost certainly increases the efficiency of the
economy, there is no reason to expect that it will result in an observed
increase in productivity.
Economists do try to account for this kind of effect by making what they call
hedonic adjustments. Literally, they take the price of a good (let s say a PC)
and adjust it (in this case upward because over time the consumer has gotten
more for less in their PCs) to take into account quality changes. But I
struggle to take seriously the notion that any economist can accurately or even
usefully re-price goods across the entire economy based on their true value
rather than their prevailing price.
What about the second factor: strategic decisions? These also have a direct
impact on the numerator. If, thanks to choices around, say, product design,
brand-building or selection of distribution channels, your product or service
is hugely attractive to customers, you will automatically have high
productivity, almost regardless of what you do to the denominator.
Take Apple. An iPhone 6, with largely the same physical properties, sells for
two times a HTC Desire because Apple has created a user experience and brand
that causes consumers to pay whatever it decides to charge. As a result, Apple
has sky-high productivity versus HTC which is struggling to make ends meet in
the smartphone business. It is simply and clearly a function of a strategic
choices influencing the numerator, not the size of the denominator.
Yet the impact of these kinds of decisions seems to be almost completely
ignored by productivity economists. It is a shame. All of the economists and
policy wonks obsessing about low U.S. productivity growth focus, at best, on
half the problem, which is like going into a fist-fight with one arm tied
behind your back. When productivity recommendations are made, they never point
out the need for smarter strategic decisions on the part of U.S. company
executives except for smarter decisions on adoption of labor-saving
technologies.
Roger Martin is a professor at and former dean of the Rotman School of
Management. He is the coauthor of Getting Beyond Better (Harvard Business
Review Press, forthcoming) and Playing to Win (Harvard Business Review Press,
2013).