Sunday 1 February 2009

In Praise Of Productivity

Economists will tell you that the surefire solution for coming out from the slowdown and achieving economic nirvana is rapid growth in productivity. But then, we hear new voices saying that growth in productivity is a double-edged sword for an economy in turmoil, and more often than not leads to a surge in unemployment. Since advances in productivity will more than account for the expected 7 to 8 percent growth, India Inc., having shed about 1 million jobs in 2008, will now create 0.3 million jobs less in 2009.

Are we then caught in a vicious cycle of productivity growth that will continue to cause less job creation and hence prevent us from making a complete recovery? Is it because productivity and efficiency growth are not keywords that we associate with most of our PSUs that we find them to be stable in uncertain times? Surely not. We will argue that it is just the opposite. It is the unusually robust productivity gains that we have achieved (been forced to achieve, some would say) during the slowdown, that is laying the groundwork for the stronger demand that will justify next year’s new hirings. It is productivity growth that has helped support and shore up overall demand at a time when a long list of other factors unrelated to productivity have suppressed it.

Because of the elimination of the inventory excesses, the terror attacks on Mumbai and Delhi, the corporate scandals, and a hostile neighbour, overall demand rose at an annual rate of only 2.2 percent during the last two quarters. With productivity rising at twice that pace, it is clear that companies have been able to satisfy demand growth even while cutting payroll costs. However, we have started seeing better news lately, with Wipro and Infosys posting good results, and giving analysts some confidence about the fundamentals of the Indian economy. Satyam alone cannot undo the good work that the industry has done in recent years. As we keep the economy on its feet, we will see these drags either fading away or completely gone. Consequently, 2009 can be the year when the benefits of a faster pace of productivity begin to lift demand across a broader swath of the economy. In short, both businesses and households can be winners next year, and creation of more jobs is likely. The caveat: keep improving productivity.

A long-run trend in productivity growth, now generally accepted as inevitable, means the economy has to sustain growth for the payrolls to expand. But that is only part of the story. The more important part is that faster productivity growth boosts demand by lifting profits and workers’ pay. It also adds to wealth as the result of a bull run in the market. The crucial link between productivity and demand is income. When an economy generates higher output, it creates an equal amount of higher income that translates into higher salaries or business profits. The key is that faster productivity growth allows the same worker to generate more income, a process that has post-liberation added handsomely to business profits and real compensation of the salaried professional.

That is the beauty of productivity gains: everyone wins. In the end, it is income growth that determines economic performance, and that is why the premise of ‘perils of productivity’ is on shaky ground.

Growth in productivity will not hold job growth and the economy back in 2009. It will spur them on.