Wednesday, 5 February 2014

The Productivity Puzzle and the Rise of the Self-Employed

Economists are struggling to explain why labour productivity is so low but Your Neighbourhood Economist could be part of the underlying reason

Puzzles can be fun but also frustrating if a solution proves elusive.  Such is the case with the “productivity puzzle” which is a phenomenon economists are having a tough time explaining.  Productivity of workers measured in output per worker has fallen following the global financial crisis and has remained weak.  The lack of an explanation for this is even more irritating as growth in productivity is one of the key factors in pushing up wages and generating higher levels of wealth.  But this dilemma may not be worth all of the worry.

What is so puzzling?

There are a number of pieces to this puzzle which are not fitting together.  The first is that companies are not investing as much.  This in itself is difficult to explain at a time when interest rates are at record lows and profitability for many companies is high.  One reason typically given is that firms are reluctant to risk money on long-term bets as the future is clouded with uncertainty.  Banks have also cut off funding to many smaller up-and-coming businesses who want to expand.  Others have pointed the finger at companies paying their executives with bonuses which prioritise rising share prices rather than investment for the future.

The next part of the riddle is falling unemployment.  A typical recession involves companies taking the opportunity to trim back their workforces.  This results in a jump in productivity as similar amounts of work are carried out by fewer workers.  Yet almost the opposite has proven true over the past few years.  Unemployment has not been as severe as in the past and the number of people out looking for work in countries such as the US and the UK is already falling.

This enigma appears even stranger when considering that unemployment in the UK has fallen to a four-year low of 7.1% while real GDP is still less than in 2008.  Companies seem to be holding onto their workers and hiring more staff instead of buying new equipment or upgrading their offices.  This may be a strategy to deal with an uncertain future (which would be temporary).  Alternatively, it could be a part of a larger shift in the way that business is done.

A reason not to worry

One of the key missing pieces could be technological change shaping new forms of work.  The Internet, along with innovations such as cloud computing, has brought down start-up costs for businesses.  Running a business these days can require little more than a laptop.  This combined with a dearth of decent jobs has seen a dramatic rise in the number of self-employed in the UK (including Your Neighbourhood Economist).

The self-employed are apt to rely mostly on manpower with little need for investment.  Output from operations with just a few workers is likely to be low or else others would have already taken advantage of such business opportunities.  Examples might include freelance web designers or landscape gardeners willing to live off sporadic work while enjoying extra spare time.

This is still not likely to be sufficient to entirely account for the low productivity that is vexing economists.  It is true that business is changing on many levels as people find new ways of harnessing the Internet and economists (including yours truly) are still grappling with what it all means.  However, if the solution involves making work less of a burden and more days working from home, it need not be so troubling after all.


  1. Is it really not worrying if skilled workers are doing 3 day weeks, or doing 80 hour weeks in jobs they are unskilled at (landscape gardening) or retiring early on profit from property?

  2. There will be some cases of what you mentioned below but even this is better than being unemployed. If such more flexible work arrangement do not turn out to be favourable, there will be the opportunity to re-enter the full-time workforce when the labour market improves.

  3. If you want to solve the puzzle, look at companies like Wippro, Infosys and other labor importers from India, China, etc.
    (look at there balance sheets on Google finance and you will see the massive rise in market share and revenue....they account today for more than 10% of India's GDP!!) Do you have the same situation in the UK?

    These companies were startups in 2000 and have become enormously wealthy in just one decade...why? because they import foreign skilled labor (engineers, lawyers, doctors, nurses, pharmacists, etc.) directly into the labor pool and displace the native citizen, all for a cut rate price. Most economist seem to be unaware of this phenomenon, but if you look into the data and demographic maps, it becomes clear.

    In the U.S. 25 million jobs have gone to both legal and illegal immigrants in the past 15 years and it accounts for our high unemployment rates in both blue collar and professional jobs....