Jawboning productivity?

Dr Cullen has told businesses to increase productivity. Although this sounds utterly ridiculous, given that businesses will make all profitable investment they can in order to make their output at a lower cost (unless you believe there is a conspiracy to keep wages low 🙂 ) there could possibly be some method to his madness.

Treasury has been working hard on the productivity issue this year, but it is a difficult issue. If we could costlessly increase our productivity then we would have no trade-offs, as output could become un-limited. As a result, the trade-off they have been interested in is the trade-off between current investment in productivity and the future benefits. To make matters even more difficult, the factors lying behind productivity remain somewhat of a black box – a subject where an individuals industry expertise trumps the musings of a whole team of economists.

Given that information regarding productivity is implicitly tied up in businesses and given that the choice of investment in infrastructure and R&D are often subject to positive spillovers, Dr Cullen’s strategy of Jawboning may be ingenious.

Jawboning is a low cost way of trying to convince people to do what you want. In many ways its similar to guilt tripping – or possibly to giving warning about a credible threat. If the Finance Ministers skills are good enough this Jawboning may lead to a greater amount of “investment” now. However, for this to truly influence the future capital stock we need to know that investment won’t just fall back once Dr Cullen’s rant has finished. In other words there needs to be some factor that will hold up firm’s investment intentions.

One way to justify this is through “positive spillover effects”. When we have positive spillover effects, we know that the optimal choice of investment and the capital stock will depend on both the firms direct payoff from doing so and the level of investment by other firms. In a simple symmetric case we can look at the following diagram to get an idea of whats going on:

The red line is the firms “reaction function” – which determines what level of investment they will choose given industry investment. The blue line is a 45 degree line that represents the case when all the firms have settled down to the equilibrium level of investment. In this case we have a linear positive spillover effect, and there is no multiple equilibrium.  Infact, the only equilibrium is where the “reaction function” crosses this 45 degree line.

As a result, Jawboning in this case is pointless (unless we believe there are true “social benefits” from this investment.

And so the point is?

However, say that the spillover was not linear:

Source: Resilience Science (link)

Taking the above graph on poverty traps (as I’m no good at drawing fancy graphs 🙂 )lets pretend that well-being at time t+1 is a firm choice of investment, and well-being at time t is the average industry choice. In this case there is positive spillovers all along the range of the choice variable – but the spillover is non-linear. In fact, there is a tipping point in the middle of the graph where the positive spillovers become so strong that a slight increase in the total level of investment will give an individual firm a large incentive to invest further.

In terms of capital investment we could think of this as a point where there is a discontinuous switch from labour intensive to capital intensive production methods.

Now in the above graph there are four equilibrium – each of these are points where the “reaction function” crosses the 45 degree line. The four eqm are :  A death equilibrium where capital investment is zero (which is unstable 🙂 ), two stable equilibrium – a low investment and a high investment one, and an unstable equilibrium.

An unstable eqm is one where any little shock will make us fly away from it too one of the others. If Dr Cullen believed we were at this unstable eqm, then a little bit of a shock from his jawboning could have a big impact.

Furthermore, if Dr Cullen believes that he is especially persuasive, then if we are at the low equilibrium a shock from him talking may be sufficient to push us up to the high equilibrium.

Do you believe it?

Ultimately, I don’t believe that this is the reason for his jawboning. When we are told that the government has done everything it can for productivity we have to take their words with a significant grain of salt (although I do believe that apprenticeship schemes and the such are a great idea for improving productivity – really this deserves its own post). Blaming industry for low productivity seems like blaming a murder victim for the crime, just so you don’t have to figure it out!

  • Not from an economic viewpoint, but from a business. There are two sides to the productivity issue. One side is infrastructure in its broadest sense which I’ll skip because the current government has been doing good work in improving it.

    The second is that in my experience you seldom get productivity increases at a company level unless there is a compelling reason to do it. The easy ones are usually done early.

    The harder ones usually require up-front money to be invested well before you see any results. Managers will always try other alternatives in NZ to capital expenditure, because capital is a hard resource to get, and carries expensive costs both in interest and in company control. That shows up particularly strongly in my industry of software development.

    If you have the ability to hire someone, then it is usually cheaper to do that rather than putting in hardware, software or systems. The gains to the bottom line usually happen far more rapidly.

    It is only after the cost of labour goes up, or the availability of the required skills goes down that you start looking at how to get better use from your existing staff.

    You notice that in the treasury graph that productivity decreases when unemployment became widespread here in the mid to late 70’s. Given the chronic shortage of capital here for any type of risk, it has been cheaper and less risky since then to hire more low-wage people to increase bottom line profits.

    Productivity is raising its head now as an issue because effectively everyone who could be employed is. It shows as chronic skill shortages and increasing wage demands. So managers start getting concerned about how to use their existing staff more efficiently.

    That is my take on it..

  • I forgot to put in the important point. Wage rate growth has been faster than NZ’s in the US, aussie, and most of the OECD since the 1970’s. Consequently the trade off point between capital investment in efficiency vs hiring another employee has been a lot lower. Similarly the availability of capital has been higher so more is available for risker ventures. Even the costs of capital have been less.

    So those companies in those societies have been doing efficiency investments earlier and more consistently. You get a cumulative spin off effect because a single company getting a return off an efficiency investment forces their competitors to follow.

  • Hi Lynn,

    I’m uncertain how any of this relates to Dr Cullen’s call for more investment. I was merely trying to come up with an explanation discussing why his call for investment might be a good way policy.

    If you do want to discuss productivity though – which is an important and interesting issue, you could make a post at the standard and I’ll make a post for a reply (after replying to a post from Terrance 🙂 ).

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