Can productivity alone be the key to faster growth?

The linkages between economic growth and employment growth need to be understood in the right perspective for drawing the appropriate policy initiatives. Employment loss resulting in a deceleration in demand can actually retard economic growth.

The effect of output expansion on employment is not positive always. Depending upon the type of technology used by the entrepreneurs, the relationship between output and employment can be ascertained. For example, with the adoption of capital-intensive technology, output may increase but employment will not. From the reverse side, with an increase in factor input (employment), output is expected to rise. But with the redundancy of labour, the output response may be nil. However, it may be argued that the demand linkage can still be positive: with enhanced employment, effective demand may increase leading to expansion in output. But the counter-argument is that the meagre wages may not lead to any acceleration in demand, notwithstanding employment expansion.

On the other hand, with the adoption of capital-intensive technology output, expansion will not be matched by employment growth. With its adverse effect on demand, a deceleration may reduce the economic growth. Thus, output expansion will be only a short-term phenomenon. While talking about advanced methods of raising productivity with labour saving techniques, one must realise that such productivity augmenting strategies will not necessarily be sustainable. The benefits of productivity increase may cater to a few stakeholders such as those who are at the top of the skill ladder and the entrepreneurs with enhanced incomes. But the rise in demand originating from the increase in income in these few hands cannot compensate the fall in mass demand due to reduced employment and wages.

Reaching stability

Based on vector auto-regression model and the corollary exercises, it is seen that both employment growth and output growth in response to price shock take a long-time horizon to indicate stability. Price incentive does not seem to be working in the long run, though in the very short run, producers may be tempted to augment production. Further, employment shock does not impact prices for a long time, though a positive employment shock may raise the prices due to a sudden hike in demand.

Variance decomposition results bring out the fact that a large part of the price variance (26% to 34%) is accounted by employment growth, both in the short and long run, indicating that employment fluctuations can cause prices to fluctuate though price does not comprise any significant variation in the employment growth.

The most important point is that the variance in the value-added growth is largely influenced by employment growth both in the short and the long run. In fact, the employment growth accounting for output variance is larger than the output variance captured by output growth itself. This tends to indicate that employment decline can cause output fall significantly through deceleration in demand. Usually, the demand side aspect is neglected as firms keep emphasising labour-cost cutting mechanisms through adoption of capital-intensive technology. Though substitution of labour through mechanisation may augment production, in the long run, such production will not be sustainable because of the lack of effective demand. The policy makers need to realise the strength of the demand linkage and accordingly employment and wage augmentation strategies need to be worked out for making economic growth sustainable in the long run.

Inflationary inducement

The fact that price variance accounts for a nominal proportion of the output variance may suggest that price incentive as a policy strategy may not be highly effective in augmenting production. Only mild inflationary tendencies may work as inducement to the producers. Hence, for economic growth to pick up, the non-price factors must be looked into. Employment growth, for example, has a major impact on output via demand acceleration. Contrarily, employment decline may curtail the aggregate demand and economic growth. Further, removal of the bottleneck in the production process would be important in maintaining a balance between demand and supply.

Productivity augmenting strategies have serious limitations though we often talk about only their positive impact on income and growth. While considering their economy-wide effects, employment levels and wages and the consequent impact on aggregate demand seem to be highly disturbing. Rise in productivity growth may raise the income in a few hands which in turn may result in a tremendous rise in inequality. However, more important is the possibility of a decline in the aggregate demand, making growth unsustainable in the long run. Even if one would argue that the future growth can draw its support from the rising income of the beneficiaries of productivity growth, such an outcome would involve serious distortions in the resource-use pattern in the production process. And this may lead to an adverse balance of payment situation, making growth highly unmaintainable.

Arup Mitra is Professor of Economics, South Asian University. Views expressed are personal