How to escape the productivity slump

Madhur Jha Global Economist & Head, Thematic Research

22 Sep 2016

We look at the potential winners and losers in the race to generate growth and jobs from services

With manufacturing productivity in the doldrums, services are fast becoming the key driver of GDP and jobs just about everywhere, but which countries have what it takes to make the most of this trend?

We’ve looked at the figures, and find Hong Kong, Singapore, the US and the UK out in front amongst the developed markets when it comes to the ability to drive productivity in services.

The four have a number of favourable conditions in common, including strong education systems, a high degree of innovation, advanced technologies and well-functioning markets.

The Philippines has improved the most in overall rank

Among emerging markets, Malaysia, Turkey, Kenya and the Philippines top our index of countries with potential to increase services productivity.

We’ve also looked at who has made the most progress in improving services potential since the global financial crisis:

The Philippines has improved the most in overall rank, with notable landmarks in foreign direct investment (FDI), technology transfer, financial-market development and innovation. China has also moved up quickly, deepening and strengthening its financial markets, as well as improving government efficiency.

Why does this matter?

Getting growth out of services

Until recently, few economists paid much attention to services productivity. One reason is that it’s hard to measure. Whether one hairdresser or doctor is more productive than another depends on the quality of the service, not just the number of people served.

Another reason is the general assumption that manufacturing productivity will always outstrip services productivity, as it’s easier to automate. It is hard to conceive of a hairdresser being able to style two people’s hair at the same time, for example.

But times are changing, and there are many reasons why governments and academics are now looking again at squeezing more growth out of services.

Slumping productivity – output per person – has become a major concern for policy-makers and markets around the world. Over time, productivity growth is the main driver of improvements in living standards, and underpins returns in asset markets.

The recent bout of weakness is pervasive across most developed and emerging countries and a key reason why incomes have stagnated. This, in turn, has likely contributed to the polarisation of politics we see in some countries.

Meanwhile, services have grown to account for nearly 70 per cent of global output, and fewer than 7 per cent of jobs in the US are now in manufacturing.

Emerging markets leapfrog

Emerging markets are also seeing a rising share of services, as traditional manufacturing-led economies such as China reorient towards services. Some emerging economies in Sub-Saharan Africa and Asia even face ‘premature de-industrialisation’, meaning they are becoming predominantly service economies without ever developing a strong industrial sector.

And now, economists are beginning to question whether productivity growth in services must inevitably be slow. Growing tradability and new digital technologies are helping to elevate services productivity in many services sectors.

Productivity growth in frontier firms in modern services averaged 5 per cent a year

According to the OECD, while overall service productivity growth still lags manufacturing, labour productivity growth in frontier firms in modern services averaged 5 per cent a year in recent years, much higher than that of frontier firms in the manufacturing sector which averaged only 3.5 per cent per annum over the same period.

Increasingly, sectors such as retail and wholesale trade, finance and information and technology can rival or even exceed the productivity performance traditionally associated with the manufacturing sector.

Higher productivity in the new services sectors such as telecommunications and IT can help raise productivity in more traditional service sectors like health and education as well. All of these in turn help boost productivity in the wider economy, including manufacturing and agriculture.

The impact of ageing populations

Services productivity growth will also become particularly important for countries with older populations. Older people spend more on health care and financial planning than manufactured goods. As populations age, the service sector will become an even larger share of the economy. And manufacturing itself is increasingly being unbundled into a series of processes from design to production to marketing and sales, most of which fall in the services sector.

Fulfilling the productivity potential in services will require the rapid adoption of new technology, processes and business models. But regulatory barriers and human capital limitations – including skills, business sophistication and an innovation culture – may be a constraint.

According to our research, Korea and India have seen their services potential deteriorate the most in recent years – a particular worry for India, which, unlike Korea, has no manufacturing base to fall back on.

Each country will have its own challenges, but what does seem clear is that – if the global slump in productivity is to be reversed – governments everywhere will need to focus more on services.