The productivity myth

Every now and then, there’s a rash of commentary on national productivity. And for the British, productivity is all part of the Brexit angst, with the OECD, the Treasury, the Bank of England and Remainers all saying the average Brit’s poor productivity just goes to show how much they need the certain comfort of being in the EU. As Hilaire Belloc put it, we must hold on to nurse, for fear of something worse.

Only this week, the OECD came out with a paper repeating its disproved nonsense about the economic consequences of Brexit, even recommending Britain should hold a second referendum to reverse the Brexit decision. To back up its analysis it claimed Britain’s labour productivity is at a standstill, while that of France, Germany the United States and the OECD averages are all improving.ⁱ

Regular readers of my articles will know I have no truck with statist statistics, averages and the neo-Keynesian analysis that goes with them. The econometricians’ analysis of productivity is a prime example of why statistics derived from questionable information should be disregarded entirely, as I will show. You can prove anything with statistics, except the truth. The OECD, which is the source of the productivity statistics quoted by politicians, uses statistics not in a genuine search for the truth, but as a cheerleader for statism. Being based in Paris this institution is particularly sympathetic to the basic concepts of European statism. It’s a wonder they tolerate private enterprise at all.

This is the organisation that brings official statistical analysis of economics, while being funded entirely by self-interested governments. However, on the face of it, productivity should be uncontentious, and hard to criticise. GDP divided by the number of hours worked is simple. How can it be misleading? Read on.

The OECD’s approach to productivity

The OECD’s brief paper, Defining and measuring productivity, quotes Paul Krugman:

Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise output per worker.ⁱⁱ

Krugman implies in this quote that productivity is a function of government and therefore by implication not that of the employer. This is plainly in contravention of the facts: an employee only produces if he or she is employed by an employer for profit. It is up to the employer to make that decision, not government. That the OECD quotes Krugman confirms the OECD’s economics are in line with his thinking.

From here, the statistical errors commence, starting with the relevance of GDP. GDP is designed to capture final consumption, and underplays the production of goods of a higher order, for example machinery, by not recording the intermediate steps in production. This important point was recently recognised in the US by the introduction of a new statistic, gross output (GO).

GO is now reported quarterly by the Bureau of Economic Analysis, and it is nearly double the GDP number. Therefore, in the US, GDP per hour worked is roughly half the realistic measure of total production. GO confirms that using GDP in a productivity formula is outrageously misleading. But the OECD does not estimate GO, and it should be noted that different countries have varying degrees of intermediate production, which makes it impossible to compare them on a like-for-like basis anyway.

We can also expose the concept of labour productivity as baloney in our daily affairs. For example, if you are in retailing, you may judge your sales staff to be productive, because they produce sales. But most of the foot-fall into your store probably has nothing to do with the salesman’s skills. The window-dresser may or may not have contributed, and are the cleaners and accountants productive, along with the warehouse staff and the van drivers who deliver to the store? Taken individually, they are a cost, difficult or impossible to relate to final sales, which makes up GDP. This is why running a business is about teams of people with complementary inputs, and to record the production of individuals in GDP terms is nonsensical.

In a free market economy, arbitrage tends to even out returns on capital employed across the full range of businesses, of which labour is only a part. In addition to labour, there is capital investment in the establishment, plus equipment and working capital. Taking all these elements together, if one business line stands out in its profitability, it will attract competition. If another business line produces insufficient return, it will be closed and its capital redeployed. After all, all forms of capital are scarce, and therefore a valued commodity to be deployed properly.

When capital is not redistributed to better effect, it is nearly always because the state intervenes. The state doesn’t want businesses to lay off workers who are part of a failed production line. Instead, the state obstructs the redistribution of capital by subsidising the uncompetitive businessman. Government also penalises profitable businesses by sequestering profits.

Furthermore, different industries deploy their capital in different ways, so within the total the contribution from human effort varies considerably. A mechanic on an automated production line supervising expensive robots cannot be averaged with a park attendant.

The government’s own GDP contribution must be excluded from any productivity calculation, as it is a drain on genuine production.

The problem with statistics such as productivity is that everyone thinks they mean something. And, of course, the political class, including finance ministers, stand for nothing and fall for anything. That notwithstanding, let us ignore the fact that this econometric gem is only paste, and recast the figures into something more meaningful. Something that a businessman will find useful as a basis for comparison in the quest for the best jurisdiction to establish his business. Something that will guide him about whether he should relocate from Britain to mainland Europe.

For this purpose, we shall select four countries in Europe from the OECD’s database, including the UK. In Table 1, we see the following:

Table 1. GDP per hour worked – US$

These are the OECD figures upon which successive British finance ministers have based their whingeing about how unproductive their taxpayers are, and if only they could be exhorted to work more productively, tax revenues would improve. For that is the state treasurer’s real interest in the matter.

A more sensible approach is to look at productivity from a businessman’s point of view. It is out of his sales revenue that he must pay both employment taxes and wages for his employees. In reverse-engineering the OECD’s figures, we must also remove government, because government is a drain on production. Then we must take out the unemployed to arrive at the number employed in the private sector. Table 2 quantifies the private sector workforce.

Table 2. Labour statistics 

It’s worth noting that there are different ways to count government employees, and that France, for example, has nationalised industries whose employees are not necessarily included in its total. The OECD’s statistics assume people of working age are as young as fifteen, which may be true in an emerging nation, but Europeans remain in education to an average age perhaps of eighteen. We have no option but to ignore these important errors.

Next, we must derive private sector GDP per private sector employee. This matches the adjustments to the work force in Table 2 with the private sector’s GDP. This is shown in Table 3.

Table 3. Private sector GDP

Our Mr (or Ms) Average is held responsible for producing a share of GDP which is lowest in France, and highest in Italy. Who would have believed it! In Table 1, the OECD told us that France was second in its productivity only to Germany, and Italy was, well, Italian.

However, to employ our Mr Average a salary must be paid along with social security and employment taxes, before a business hopefully profits from his labour. This is our final adjustment in our quest to seek more relevant figures, from the businessman’s point of view. This is shown in our last table, Table 4.

Table 4. Return on employment

The conclusion of this exercise is that notwithstanding Brexit, the average businessman employing the average employee gets the best return on his investment in human capital in the UK, followed by Italy. If he has a predilection for France, he better secure advantageous terms from the government for the life of his investment. And Britain even beats Germany, hands down. Using the OECD’s own figures, recast to reflect commercial reality, the results deny the OECD’s own conclusions.

These figures are, of course, far from perfect. As mentioned above, if the EU produced figures for GO, including intermediate processes as well as final values for goods, return per employee would look far better. Germany, with its strong manufacturing base is probably most understated, while Italy and France less so. Britain may be somewhere in the middle.

Human capital, being employed to do different things, cannot be measured by anyone, except by he who pays the salaries.

Worst of all, the OECD approach encourages politicians, and economists beholden to the state, to ignore the impact of employment taxes. It is here that the UK scores relatively well and France is a disaster.

Instead of criticising the private sector for being unproductive, it is surely more relevant for governments to look at their own burdens on production, and act accordingly.

ⁱSee Figure 4A on page 19: http://www.oecd.org/eco/surveys/United-Kingdom-2017-OECD-economic-survey-overview.pdf

ⁱⁱSee https://www.oecd.org/std/productivity-stats/40526851.pdf