From: Foundation for Economic Growth
Analysing Growth from a Labour Perspective.
By Peter Gallagher
Jul 8, 2004, 17:36
Perspective 1: Analysing Growth from a labour perspective.
The PM in an address to the Auckland Chamber of Commerce, following the recent budget, stated:
“It’s been estimated that up to a third of the income gap between New Zealand and the OECD average could be closed by raising labour force participation to those Scandinavian levels, and that will largely be about increasing women’s participation”.
Ignoring the moral argument: namely what right does the government have to push more women into the workforce, we can analyse her statement from an economic point of view as follows.
The implication in the speech is that by simply adding more women to the workforce we can PERMANENTLY narrow the gap between us and the OECD average. As we will see below this view is mistaken.
The economic growth rate, considered as the growth in GDP per person, can be analysed in a number of different ways.
For example one way is:
economic growth rate = %change in labour utilisation + %change in labour productivity
For example: with a static population, if the labour force grows by 1% pa and labour productivity by 2% pa then the economic growth rate is 3%.
The first term on the right hand side of this equation essentially refers to how many hours are worked. It can be increased by people working more hours and/or more people working. For example the government could legislate that everyone must work 60 hours per week. This would increase labour utilisation and hence economic output.
Note that if the population increases by 1% and labour utilisation increases by 1% with no change in labour productivity then in fact there is NO growth in GDP per person. Therefore a simple rule of thumb would be to think of the first term as the being the change in the working population relative to the change in population.
Note also, that an increase in labour utilisation would NOT increase the growth rate, at least not in the long term, unless there was a continuous stream of people entering the workforce or if the existing workforce worked more and more hours. There will be a short-term boost to growth as labour utilisation increases to its ‘new’ value (eg say from 40% to 70%) but this growth effect would level off. In other words a higher level of GDP per person would be obtained but not permanent change in the growth rate! An increased growth rate would occur until GDP per person levelled off at the new ‘steady state’ amount. In the jargon this is known as ‘convergence’.
The second term relates to how productive we are – how many widgets we make per hour as compared to the first term, which is how many hours we spend making widgets. This (second) term can be subdivided into the growth in capital per worker plus the growth in innovation. By utilising more capital per worker we can make more widgets per hour. However, adding more and more capital will not increase growth forever (due to the principle of diminishing returns). The same argument as above, namely ‘convergence’ again applies.
The way to achieve sustained growth is by innovation or improved technology - in other words by working smarter. This growth due to innovation is called total factor productivity (TFP).
It is interesting to analyse the so-called ‘Asian Miracle’ in terms of the above concepts. It has often been claimed that their exceptional growth was due to rapid growth in TFP. However, studies have shown that their growth was mainly due to an increase in labour (and capital) utilisation (as well as human capital i.e. education). The TFP (‘innovation’) part was in fact no better than in the US. Indeed, in Singapore’s case its TFP growth from 1966-1990 was only 0.2% (compared with Taiwan at 2.6% for the same period).
In summary, therefore, with regard to the PM’s above comment: her prescription may temporarily close the GDP per person gap but it will do nothing for long-term growth. The key is productivity not just the number of workers.
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