Productivity improvements should trigger a virtuous cycle that, under the right competitive conditions, will result in economic growth. Productivity creates surpluses. When surpluses are distributed among customers, employees and investors, an increase in demand is created across sectors. The increase in demand can only be met with increased output, which, if it occurs across multiple sectors, ensures increased employment and GDP growth overall.
Lower Prices, Higher Profits
Assume that productivity increases in a specific sector in the form of more efficient use of resources and more product and service innovations. These enable either creation of higher value added and/or of lower costs, thus creating a surplus for the companies involved.
This surplus is distributed as lower prices to consumers if the right competitive intensity exists in the sector. In addition, the surplus may also be distributed as higher profits to owners or higher salaries to employees. In all, disposable income rises.
In a competitive sector lower prices and higher spending stimulate demand. More broadly, increased disposable income and higher profits stimulate demand in other sectors. Increased demand necessitates increased supply.
On the supply side, once further capacity utilization is exhausted as a source of output growth, increased output within existing capacity will be accommodated by the same measures that result in improved productivity. For example, measures to improve organization of functions and tasks (OFT), in our report’s manufacturing sectors, will produce both labor productivity increases and output growth within existing capacity.
However, at some point accommodating further growth will require new capacity.
Savings and Investment
The same increase in purchasing power already noted is also a source of the increased savings necessary for financing the new capacity Individuals in the economy will have more real income at their disposal to save as well as to spend.
With effective intermediaries, the resources set aside (savings) will be made available for investment. Investment will flow both to the maintenance and upgrade of existing capacity as well as the installation of new capacity (investment). This is the supply-side requirement to meet output growth.
Finally, fair and intense competition in all sectors of the economy will ensure that the retained earnings available for reinvestment occur in the most productive companies. This will trigger the virtuous cycle anew.
Implications for Employment
As for the effect on employment, in some sectors the growth in output due to lower prices more than compensates for the jobs lost through measures that improve labor productivity, and sector employment increases. (We believe this can occur, for example, in the Turkish telecommunications sector. It has already happened as modern players have penetrated the FMCG retail sector.)
Of course, in other instances output does not grow as quickly as productivity, and sector employment decreases (experienced in the Turkish cement sector in the 1990s). Nevertheless, positive spillover effects among sectors from higher process efficiency and product and service innovations help provide redeployment opportunities to displaced workers. The growth in output in mature industries will also create growth and employment in related industries (e.g., upstream and downstream sectors).
In either case, however, the increase in disposable income results in higher economy-wide output, and this means higher GDP and employment growth in the economy.
Challenges of Country Competitiveness
For a tradable goods and/or services sector, competitiveness could be interpreted as the share that a country captures in export markets. For a specific good or service of a given quality, there are two key determinants of its price and, thus, its competitiveness. First, is the cost of factor inputs used to produce the good or service – e.g. labor costs. Second, is the efficiency with which those inputs are used – i.e. the amount of the good or service produced per unit of factor input.
As a country develops, its factor input cost advantages—particularly labor costs—will diminish. Therefore, competitive advantage based only on the cost of factor inputs is not sustainable. The only way a sector can achieve sustained competitiveness is through rapid and continuous productivity growth.
This doctrine is particularly important to the two major export sectors studied, apparel and automotive parts.
Correlation: Labor Productivity and GDP per CapitaThe empirical evidence that these mechanics truly work comes from comparing countries’ labor productivities and GDP per capita levels. It is true that it is not possible to prove causality in any one time frame. However, the correlation between GDP per capita and labor productivity is very strong across developed and developing economies alike. The data reinforces the presence of a virtuous cycle in which productivity growth leads to GDP growth.
Turkish economic history also demonstrates the same link. The period of high GDP per capita growth from 1980 to 1990 coincides with a period of higher productivity growth. The empirical data not only reinforces the fundamental link between productivity growth and output, but also the link between productivity and employment. The same holds for other recently emerged countries during their takeoff years. It should dispel any fears about unemployment.