The nuanced case for policies to improve productivity

The conventional wisdom on productivity is tied up with capital formation. As businesses make capital investments, it increases worker productivity. 

I have three problems with this line of reasoning, especially for developing countries grappling with the challenge of providing jobs for the new workforce entrants as well as those moving out of agriculture. For these countries, productivity improvement is just a means to achieve increased incomes for their workers as well as to create new jobs. But it can be so that while headline productivity numbers improve, increases in worker incomes may be disproportionately lower. 

To start with, productivity enhancements can come from investments in either physical technologies or human skills or both. Improvements in physical infrastructure - plant and machinery, information and communication technologies etc - increases the productivity even with minimal incremental human capital formation. A semi-automation of factory floor in a low technology manufacturing also increases output considerably without much worker capacity augmentation. Returns from such investments are disproportionately likely to be captured by the owners of physical capital. 

The second concerns the capital investment focused definition of productivity. What about productivity that is driven by increases in human capital formation – education, skill acquisition, etc? The less developed countries are characterized by poor levels of primary school learning outcomes, abysmal rate of employability among professional graduates, very low penetration of skill trainings, and limited use of apprentice system. Or the use of better management tools by the millions of small enterprises that dot the economic landscape of countries like India. Given their massive antecedent lags, there is a huge potential for large productivity gains from improvements in any of them. In fact, in terms of bang for the buck, investments in these areas are likely to be far superior in resource-constrained countries. Alternatively, the returns from every unit invested in human capital formation far exceed that invested in physical capital formation. 

It is, of course, true that co-ordination problems and externalities come in the way of the practical realization of gains from human capital investments. Why should the private sector invest in human capital formation if it cannot appropriate the full benefits from such investments? How can public financed skill training and apprentice promotion schemes be closely integrated with industry requirements? But these are matters of getting the enabling policy and implementation design right than policy design failings.  

My last problem with capital investment focused productivity improvement strategy comes from its adverse impact on jobs. There is a very rich body of evidence that robots and automation have been destroying or displacing jobs. It has even been estimated that a majority of today's jobs are at risk of being replaced by automation.  

Productivity enhancement which comes at the expense of jobs imposes prohibitive welfare costs. This is more so for developing countries, where social safety nets are grossly inadequate. Here, the rate of job destruction far exceeds that of job creation. 

Public policy in developing countries seeks an unqualified increase in productivity improvement through increases in physical capital formation. This is reflected in the large subsidies and fiscal concessions provided to encourage capital investments. In fact, industrial policy in these countries is largely about fiscal concessions. In contrast, initiatives that enhance human capital investment is largely forgotten and, therefore, marginalized. Public support for physical capital investments are orders of magnitude more than that for human capital investments. This should constitute arguably the least discussed and among the most important resource misallocation problems in the context of poor human capacity constrained developing economies.

The policy implication of this argument is that the unambiguous focus on productivity improvements through physical capital formation need to be more nuanced. We need to acknowledge that, while very important, it may not be an unalloyed good. For poor developing countries with weak human resource development, the pursuit of productivity enhancement should involve encouraging both human and physical capital formation.