The limits of productivity

The traditional, industry-based macro-economic model establishes that, with the technological development and the introduction of improved production methods the productivity of the whole economy increases, with the result that raw materials are available at a lower price, increased labor productivity also means that the labor cost per unit of product is lower, so manufactured goods are also cheaper. At the same time, the increased productivity means that the hourly wages also increase, so there is more money available for discretionary spending and the economy grows. However as I pointed out some weeks ago, these increases in productivity have a limit.

Let us consider for a moment a country with 100 workers in its workforce, who produce enough goods for internal consumption and exports, with only a function 5% unemployment to ensure a healthy labor market and all that while the companies make an adequate profit on their investment even after the necessary reinvestments to keep the industries running. Now imagine that a revolutionary technology allows them to produce the same goods with one tenth of the labor. The productivity gains will naturally boost the salaries of the workers, maybe not by a factor 10, because part of the productivity gains will go into lowering the prices of the final products, but possibly 5 times as high as before.

Photo: National Portrait Gallery

These improvement in productivity has two immediate effects: the first one is that 90% of the workforce is unemployed and are likely to stop buying goods; the second is that the total amount of wages paid has, surprisingly, shrank by 50%. The combination of these two effects will result in a reduction of the total size of the economy, since the unemployed cannot pay for goods and the few employed might increase their spending, but not enough to compensate for the unemployed: earning five times as much money does not mean that you will have five cell phones or five cars.

The classical answer to this problem is that the unemployed will "figure out" new products to get employed and increase the size of the economy again. In practice, it might be necessary for the government to raise taxes so that the earnings of the employed and the company owners partially fund unemployment benefits to keep the economy and the families afloat in the meantime.

This is, to some extent, what is happening with globalization: productivity improvements, frequently by offshoring, has a significant impact in the destruction of jobs and increases inequality by paying better the few workers that are still employed. On the other hand, the relocated production is not cheap enough that the new laborers can afford the products they are manufacturing, which are mostly intended (and priced) for the home countries of the industries. At the same time, the increasing unemployment or underemployment of the nationals can produce an economic crisis in the countries of origin.

When the demand for goods clearly exceeds the production capabilities of all nations together, trade provides the incredible benefit of allowing each country to focus on the task where they had comparative advantage (the so-called Pareto efficiency) while buying the rest of the goods from countries where they can be produced more efficiently. However, uncontrolled globalization can lead, as we are seeing these days, to gaping inequality and, what is worse in the long term, resource depletion.

Industrial procedures were conceived at a time where our ability to influence nature and extract resources was significantly limited by our lack of technology. The advances in the intervening 150 years are so huge that we are bound (as John Maynard Keynes pointed out decades ago) to run out of raw materials to process and goods to produce, and then we will be in trouble. Let us hope that the economic powers that be manage to recognize the situation and steer us away from that cliff in time. Have a nice evning