- Secular growth in services has significantly dampened overall productivity growth – but the shock of COVID has raised hopes of reversing that trend.
- Raising the productivity growth of the services sector could unlock huge potential, but the hurdles remain high – lower expectations should be maintained.
- Overestimating the effect of the pandemic on the economy could lead to costs that would vary among stakeholders.
A boost to productivity growth is a commonly cited macroeconomic liner of the COVID-19 crisis. After lockdowns and social distancing forced consumers and businesses to adapt to digital channels, even for services, a credible story of a productivity tailwind has emerged.
When one considers such a structural tailwind alongside the cyclical productivity gains associated with tight labor markets (periods in which companies struggle to find workers and accelerate their technology investments), it is tempting to s ‘expect much higher growth.
However, as the discourse on productivity proliferates, it is important that policymakers, investors and business leaders remain realistic about the macroeconomic benefits. Obviously, something is moving at the microeconomic level, but extrapolations to macroeconomics are dangerous and exuberant expectations could come at a cost.
To develop a realistic understanding of the potential, we need to study the role that services play in overall productivity growth; what constitutes a transformative growth impulse; and what invisible hurdles are slowing the productivity growth of the service sector in the post-COVID economy.
Services have slowed productivity growth for decades
Advanced economies have experienced slow productivity growth for many years, but it’s worth remembering that aggregates always mask important details. A closer look at the US economy (see chart below) illustrates the dynamics. Contrary to popular belief, high productivity growth has been a lingering feature in many industries over the decades, as shown by the green colors in the graph. The problem is that these sectors represent an increasingly small part of the economy, dominated by the production of goods.
Meanwhile, the service economy has steadily increased its share in total output, but productivity growth has remained stubbornly low, as evidenced by the red colors, aggregate Productivity growth.
If we hypothetically “unbalance” this change in composition (ie (which takes into account the growth of labor, capital and productivity) by about 2%.
This not only tells us that the service economy has enormous potential for productivity growth, but also that any upward movement will have to happen here. If COVID-19 is truly a catalyst for such a shift, the benefit could be significant. The question is what size.
Understanding the transformations of growth
What does it take to transform growth? The story is a good starting point for unpacking the answer. The last time the US economy experienced a strong growth spurt was during the information, communication and technology (ICT) revolution of the 1990s, which shrank to triple digits: 30, 100 and 10. The dramatic shift in productivity growth followed 30 years of sustained investment in network computing; it then increased total factor productivity growth in the United States by 100 basis points, and that change lasted for about 10 years.
So if a COVID-induced 100bp growth transformation sounds like a high bar, that’s because it is.
First, consider that the upscaling of ICT was achieved because it revolved around a widely applicable technology that simultaneously reached many sectors of the economy. But the potential for COVID is a tale of countless different marginal adjustments across many different industries, companies and business models.
It’s tempting to take case studies of business productivity gains, extrapolate them and add them up – a bottom-up approach much like one might go about identifying cost savings in a large organization. But such micro-to-macro extrapolations are dangerous. When uncertain changes result from countless adjustments, there will be a wide distribution of results – both in magnitude and timing, as the adjustments themselves vary widely in their nature.
Second, don’t forget the baseline. In the 1990s, 100 basis points were transformative because the benchmark productivity growth rate was already 70 basis points and ICT took it to a very high level of 1.7%. But in recent years, productivity growth has been very low. If productivity growth were to rebound 100 basis points to around 1%, that would be a welcome improvement in recent years, but it would be a far cry from the transformative 1.7% of the 1990s.
Third, returning to our chart above, take the current shares of the sector in the economy, but assume that in the coming years the service economy could reach the average productivity growth achieved in the goods economy. over the past 70 years. This would increase overall growth by around 80 basis points.
What is the World Economic Forum doing on digital trade?
The Fourth Industrial Revolution – driven by rapid technological change and digitization – has already had a profound impact on world trade, economic growth and social progress. Cross-border e-commerce has generated billions of dollars in economic activity continuing to accelerate and the ability for data to cross borders underpins new business models, increasing global GDP by 10% in the past decade alone. .
The application of emerging technologies in trade aims to increase efficiency and inclusiveness in global trade by enabling more small and medium-sized enterprises (SMEs) to repeat its advantages and by closing the economic gap between developed and developing countries.
However, digital trade barriers, including outdated regulations and fragmented governance of emerging technologies, could potentially hamper these gains. We lead the charge of applying 4IR technologies to make international trade more inclusive and efficient, ranging from enabling e-commerce and digital payments to designing trade standards and policies around emerging technologies (“TradeTech”) .
Four reality tests of potential at the company level
There are other reasons why large increases in productivity should be viewed with caution. Microeconomic barriers are easily overlooked in the face of the remarkable agility consumers and businesses have shown during this crisis. We highlight four.
Parallelism – when the processes are duplicated. Consider online education and e-health, which are often cited as COVID-induced breakthroughs in service delivery. Either way, the physical and virtual processes must now run in parallel, which adds a layer of cost for what is the same output (and often worse). This indicates lower productivity, not higher. To unleash productivity growth, businesses must find ways to make the extra costs translate into more valuable services or reach many more customers.
Dilution – when low efficiency steps are added to a service. Consider the online grocery deals that have grown in popularity during the pandemic and added last mile of delivery to retail operations. This low productivity activity was previously carried out by households and therefore excluded from the productivity figures of the retail trade. So adding the last mile to the retail transaction will be a drag on productivity, not a boost. To compensate for the slowdown in productivity, companies must now work harder to become more efficient in all of their operations.
Adhesion – when the change in behavior is situational. Consider a major technological change such as network computing which is cheaper and better technology. Strong network effects provided autonomous dynamics until the penetration was very high. But many of the marginal and scattered changes triggered by COVID have a ‘work around’ logic and could normalize when the context does. As a simple litmus test for rigidity, we need to ask ourselves whether consumers are generally keen to accelerate virtualization or reclaim their pre-COVID realities.
Adoption – where there are obstacles to absorption and timely upgrading. Even when change is compelling and the benefits are clear, the technological skill set of an economy is not homogeneous across sectors, let alone the differences in political, regulatory and cultural barriers to change. adoption. If online education was – hypothetically – superior to the classroom experience, would teachers and their unions support a structural shift towards online learning with fewer teachers?
Reasons for realistic optimism
While optimism is justified, exuberance is not. Overestimating the effect of COVID on the economy could lead to costs that would vary among stakeholders.
Monetary policy makers have the most to lose in the face of unrealistic expectations. Expecting modest productivity gains, such as those brought about by cyclically tight labor markets, should help them avoid the policy mistake of being too tight. But assuming a structural productivity boom would risk making the reverse policy error. The overestimation of the capacity of the economy could prove to be the conceptual basis of a policy which is systematically too loose.
Investors also stand to lose if unrealistic expectations of productivity growth lead them to pay unwarranted valuations in all asset classes. These valuations should be reset lower when growth is below expectations.
On the other hand, business leaders should exuberant because their instinct is to make the most of the lessons of the crisis and to innovate. Individually, they are at the head of microeconomic renewal, which will sometimes succeed and sometimes fail. Yet, collectively, their best efforts offer the credible prospect of a macroeconomic tailwind, if not a transformation in growth.