Underwritten by Tristan James Jr.
- Technology fuels productivity growth but tight labour markets provide the spark for this growth because firms typically need to make better use of technology when hiring new employees is not possible.
- The tight labour market conditions that can spur productivity growth tend to be localised and so economies benefit in different ways and at different rates.
- Policymakers should view tight labour markets as both a risk and an opportunity to see productivity grow.
The idea that technology drives productivity growth is both a commonplace and a common frustration. Economies operating at or near the technological frontier have long seen sagging trend growth rates despite marvellous technology – from artificial intelligence to bioengineering to robotics – proliferating at breakneck speed.
This matters because productivity, or output per input, pays for higher wages and is the foundation of long-run prosperity. In that sense, it matters most in rich economies where higher productivity growth would allow political debates to shift from (re-)distributing a relatively stagnant economic pie to sharing a growing one.
Technology is critical to productivity growth, but tight labour markets provide the spark to fuel this growth.
Philipp Carlsson Szlezak
So how can cyclical tightness spur productivity growth? Which types of economies are set to benefit from this relationship? And why should policymakers see tight labour markets as both an opportunity and risk?
Understanding the spark of productivity growth
Availability is often not enough to prompt broad adoption and utilisation of technology – integration can be costly and there may be implementation risks. It is often easier for firms to continue to grow with the next incremental hire.
The charts below back up this observation. The chart on the left correlates more than 60 years of US business investment (relative to its 5-year average) with 5-year productivity growth. If simple availability and investment in technology drove productivity, we would see a relationship, but that is not the case.
The fuel of productivity growth is global, but the spark is local
While the frontier of technology can diffuse around the globe through trade and global value chains, the labour market conditions that provide the spark for adoption are far more localised. This means that productivity growth may diverge in countries with similar technological capabilities.
Rapid tightening – or loosening – of labour markets can occur as the byproduct of strong cyclical dynamics (such as the recovery currently underway). Or it can happen as the result of the structural organisation of local labour markets. In other words, economies have different capabilities when it comes to harnessing the nexus between labour market tightness and productivity growth.
Consider the difference between Europe and the US, two advanced economies that operate at the technological frontier. The US is set to benefit from a tight labour market as the lack of easy labour is already forcing firms to invest and reinvent their businesses and processes. This will underpin not only faster growth, but also allow workers to claim a growing share of output.
Balancing the risks and benefits of tight labour markets
Ignoring the benefits of tight labour markets could come at a cost for policymakers and executives. Take once more the US economy. It is on a path to achieving higher output in 2024 than was once expected pre-pandemic, i.e. “overshooting” its old trend path. Owing to strong and sustained fiscal stimulus, the rapid return to labour market tightness has been framed as an inflationary threat. Often a picture is painted of an impending wage-price spiral and a Federal Reserve falling behind the curve and smothering the cycle once forced to raise rates to reign in price growth.
The benefits of a hot economy, as outlined above, represent as much a macroeconomic opportunity as a threat – two dynamics that need to be balanced. Part of this balancing act is acknowledging that tight labour markets push productivity growth and thereby can expand an economy’s capacity. This would actually narrow the dreaded overshoot, even as economic activity remains strong.
45'MEDIA 