Productivity incentives

This post is by PaulL, a regular commentor and occasional contributor. It is tangentially related to the series on effective marginal tax rates and incentives to work. The index to all posts in the series can be found here.

NZ is a relatively low productivity country, with low productivity growth, as compared to developed western countries. This should be a concern to us. Productivity is fundamentally a measure of how much stuff we make from given inputs – how much stuff we make from an hour of work, how much capital and property we need to make things.

Productivity is the predicter of long term wealth for a country. Wealth isn’t everything, but it isn’t nothing either. Everything else being equal, most people would prefer to be wealthier.

NZ is currently running into worker shortages. There aren’t as many workers as we need to make all the things we want to make (whether products or services). This is reflected in our low unemployment rate. We either need more workers, or we need our workers to make more stuff (i.e. increase productivity).

Many people are suggesting that the correct answer is to increase immigration (again). Whilst this is a way to access more workers, it also increases our population. More people need more stuff, so we end up in a cycle where we import workers, who increase demand for products and services, so we need more workers.

There have been some posts recently about how the Labour government are restricting immigration so as to drive up wages, and how that’s some form of voodoo economics. My question is, if that’s not how you drive up productivity, then what is?

At the margin it seems to me that the main workforce benefit from immigrants is that they are mostly in their prime working years, and very few of them go onto a benefit. The workforce participation rate for immigrants is therefore higher than for NZ born, partly due to demographics, partly due to immigrants being a self selecting group of people with enough gumption to get up and move to another country.

In this post I want to put an alternative position to simply importing workers. We talk about NZ being a low productivity country, but when we don’t have enough workers we immediately start talking about importing more workers, instead of talking about how to make all the products and services we want with the workers we have.

Note that I am not advocating zero immigration. Rather I’m advocating that immigration levels about at the average of the western world would be OK, rather than having one of the higher immigration levels in the western world.

Immigration seems to be a purely stopgap measure anyway – forecasts of NZ’s population seem to think immigration will slow in a couple of decades anyway. What are we going to do then, and whatever that is, why don’t we do it now?

My proposition is fourfold:

1. Immigrants don’t solve the problem, they simply postpone it. Sooner or later the world population will stop growing and all countries will need to work out how to live with the reducing worker base they have. Immigration cannot continue forever
2. There’s a chicken and egg situation with wages and productivity – increased wages might force investment in productivity improvement, conversely investment in productivity improvement might lead to increased wages
3. We have people in NZ who are in their prime working years, but aren’t part of the labour force. If those people were working we’d have more employees without having significantly more demand – i.e. this is a better source of workers than immigration
4. Government doesn’t directly drive productivity, but NZ’s current settings don’t encourage productivity growth – at the margin the government is often in the way

Start with productivity growth. Increasing a worker’s productivity requires a combination of investment by the employee and the employer, and may require training and increased capital investment.

In order to increase a staff member’s productivity we need to identify ways for them to do more in a given time. This may be through identifying the most productive people in a workforce, then analysing what they are doing, and training other staff to do the same. It may involve investment in automation or other capital investment in labour saving tools that deliver improvements. 

These changes require commitment from both the worker to learn new skills and ways of working, and the employer, to invest time and money in identifying those improvements and bringing them to the worker. It may require investment in formal training – although in general I’m a sceptic on much formal training in a workplace context, believing that on-the-job coaching is generally far more effective.

The question is what drives employers and employees to make this investment? Clearly market competition in NZ isn’t sufficient to trigger this, as evidenced by our low productivity growth. However, a shortage of workers (and associated increase in wages) may be the force that’s needed for employers to start investing. When your staff move from $24 per hour to $28 or $29 per hour, you may start thinking about how you can do the same job with 5 staff that you used to do with 6.

An obvious example of this is the automated ordering machines at McDonald’s – at some point staff costs were high enough that McDonald’s decided it would be cheaper to put in machines. Some people look at this and worry that we’re heading to a world that runs out of jobs as we’re all replaced by robots. I look at it instead as exactly what we want – the more automation and the fewer workers in a business the more productivity and pay we have. The easier jobs get automated, by definition the jobs that are left are less automatable, and therefore higher skill and higher paid.

We could consider the example of a dairy farm (note the risks of giving a farming example when you’re a non-farmer). To make our example clearer, we’ll consider a large commercial dairy farm with multiple milking sheds.  Perhaps we have 5 farms within the operation, each with 300 cows and a shed.  And further, those sheds have 3 staff in total, because they milk twice a day, and 7 days a week, so they need 3 staff to cover.

The first thing the corporate could do is to notice that one farm is milking 350 cows with the same 3 staff as the others.  So they could ask “what is that team doing differently that they milk 1/6^th more cows than the rest.” They could go and review, and perhaps determine that the milking shed is a bit larger, or perhaps laid out differently, or the staff using a different process.

They could also look at the state of the art, and work out that many farms have moved to milking once a day. If you milk once a day you don’t need as many staff, maybe you now only need 2, but you perhaps need to invest in changes to your milking sheds and storage.

They may look at the milking sheds, and work out that modernising to the latest layout and milking technology would let them milk more cows in the same time, or with less labour input.

Finally, they might look at their milk quality, and realise that training their staff on detecting mastitis, or working on hygiene protocols, delivers higher quality milk. Perhaps that higher quality milk is worth more – so we’ve increased productivity by increasing the value of the product we’re producing.

I would note that the farming sector is actually one of the rare rays of light in the NZ productivity stats – perhaps due to being exposed to international competition.

I wonder whether we need to change the national conversation. Instead of talking about staff shortages and increasing wage inflation, we need to talk about the opportunity to invest and increase productivity. Perhaps if that is top of mind for managers and employees both, then it will lead to a virtuous cycle of increasing productivity. As long as everyone is talking about importing more staff there’s no real drive to work on productivity.

We also need to consider our workforce participation rate. The series I’ve been working through on incentives to work has a corollary in productivity. Increasing productivity requires some level of commitment from the worker, they need to work harder or differently. They need to care. 

Normally an employer would incentivise this commitment with pay. When you complete your level 3 certification, I’ll pay you more. When you hit this production target I’ll give you a bonus. If you do this training in your own time, then once it’s complete I’ll pay you $2 an hour more.

The problem is that the linkage from pay to net income is broken. When I pay you $2 more an hour, the government snaffles a big slice of that – you only get a small fraction of it (sometimes as low as 15c in the dollar).  If your household income doesn’t change much when your pay goes from $22 an hour to $30 an hour, then why would you want to take that promotion, or work harder?

We need to improve the returns to working if we expect people to want to work harder or even differently. Government policy is in the way of that.

In the meantime (before that is fixed) employers could look at non-financial ways to incent staff. Finish your work on a Thursday, I’ll give you Friday off. Everyone hits their productivity target this week, beers for everyone on Friday. Staff value many things other than money, and when more money only ends up in the government’s pockets, you may need to be innovative with how you reward.

Government also impacts on productivity in numerous small ways. Pettifogging government regulation saps productivity. I talked to a guy the other day who had a contract for pest control. To do a 10 minute job he needed 30 minutes of paperwork. The paperwork didn’t really improve safety, it was just government enforced paperwork. 

We could also talk about people mowing road sides with three safety trucks. That’s four people doing a job one person used to do. I can perhaps understand one safety truck, but I feel that there must be very significant diminishing returns to the extra trucks. Government doesn’t directly regulate this. However, I suspect any digging into the history of safety trucks will tell you that someone decided they couldn’t have a “race to the bottom” and so they’ve mandated a minimum number of them. Presumably the maker/importer/operator of safety trucks had their fingers in that.

There will also be a myriad of tax implications for investment in productivity improvement. Other countries explicitly allow shortened depreciation cycles for capital investment, and provide tax deductions for research and development that might lead to improved productivity. I’m not close to the NZ detail, but I certainly haven’t seen national conversations about incentivising investment in productivity.  Typically I see conversations about how business has tax loopholes that need closing. 

Equally, I haven’t seen conversations about making investment by workers (such as in training or education) tax deductable for them. Of course, we could also consider the risible quality of some of our educational institutions, and whether the education they offer in fact improves productivity at all. I’d also extend that to our management training – NZ managers seem pretty ineffective by international standards, and many of those I’ve encountered have little understanding of how productivity impacts on an organisation’s profitability.

Overall, whilst I see occasional conversation (in the right circles) about our low productivity growth, I don’t see people connecting it directly to our national wealth. I don’t see any focus on the myriad of small changes that are needed to make a difference to productivity at the micro level. I think that’s a pity, and I think there’s room for one of our political parties to put some attention into this in the upcoming electoral cycle. I can see this as a left wing policy (increased productivity increases wages and therefore wellbeing), I can see this as a right wing policy (driving business investment to improve our national accounts). Actually, it shouldn’t be ideological at all, it should just be good management of our economy.