There is no easy way to riches

tekst na srpskom

“Productivity isn’t everything, but in the long run it is almost everything.”

If an individual, business or country wants to grow and become well-off they should ponder carefully this short statement by Paul Krugman - one of today’s most distinguished economists. Riches don’t just fall into our lap they have to come from somewhere.

Basically there are three sources of growth. It’s well understood that you can increase production by expanding your labor force or investing in new plant and equipment. But the pivotal role of the third source of growth – productivity – is often more difficult to comprehend.  In essence you can view productivity as how intelligently you use labor and capital to produce and deliver goods and services. You don’t just throw man and machine together and hope that they get along in the best interests of your customer. No - not only do you ensure that the person and equipment are trained and designed to function smoothly together but you also make sure that they operate in environment that allows them to react to the ever varying wishes of the customer. That allows for change, adaption and responsiveness. How effectively an operation is put together and functions yields efficiency gains which lets you produce more for every unit of input used. In short productivity increases don’t just come from increases in capital and labor but also from better production, management and distribution methods.

A large body of empirical literature shows that productivity is an important determinant of differences in income levels across countries and that productivity growth is the ultimate and the only lasting route to prosperity. The World Bank recently published a report “Unleashing Prosperity” analyzing sources of growth in Eastern Europe, including Serbia, and the former Soviet Union. The report unequivocally shows productivity as the decisive source of increased growth and living standards across the region over the past decade or so. Between 1999 and 2007 income per capita in these countries rose by more than 50 percent, lifting around 50 million people out of poverty. According to the report, out of 5.42 percent annual growth rate over the period of 1999 – 2005 all of 4.43 percent came from a surge in total factor productivity (TFP). The contribution of capital accumulation was 0.72 percent, and that of labor force growth was only 0.27 percent. In other words, productivity accounted for over 80 percent of total output growth. What’s more productivity growth in the region, when compared to the countries and regions in the world, was second only to China.

So where did all these productivity gains come from?  As market forces took hold in the region, resources literally fled from less productive sectors and went to where they could be put to better use; similarly they quit less productive firms for more productive firms. Moreover individual firms themselves became a lot more dynamic, often in the face of stiff competition in a rapidly changing world. 

It’s not surprising that in previously centrally planned economies, unaccustomed to choice, guidance and assistance that the main shift in growth should be out of overmanned manufacturing to a burgeoning array of new financial, technical and human services. This is particularly true for the new EU countries of Eastern Europe. The productivity levels of these early reformers are twice those of the poorer late reforming CIS countries.  But even the CIS countries have witnessed a dramatic reallocation of resources from manufacturing to agriculture, as agriculture shed primitive production methods and made rapid efficiency gains.  Despite these seismic shifts in sector growth it is important to note that the productivity surge was largely attributable to productivity achievements in the firms that successfully weathered the transition. There is a lot of evidence to suggest that the firms which made the greatest leaps forward did so when they were operating in a competitive environment that allowed in new entrants and was unforgiving of obsolete inefficient companies, ensuring their quick exit.

So where does Serbia stand in all this?  Like many other countries in South East Europe -due to recent history - it is a late reformer still requiring a significant reallocation of resources across sectors and firms. Though not previously a centrally planned economy the shifts in resources have also been out of manufacturing and into services and agriculture.  This has been accompanied by labor-shedding as firms struggled to become more productive. The exact same phenomenon occurred in all the new East European EU countries. But just as these countries turned the corner and started generating new jobs (on a net basis) five to six years after they embarked on their reforms, so too can Serbia turn the corner. Its unemployment rate fell for the first time last year. Privatized companies in Serbia show increased profitability and productivity giving greater opportunity for reinvestment and expansion.

This calls for policy reforms to accelerate the pace of change. The process of creative destruction (that is, the exit of unprofitable firms and the entry of more productive ones) needs to be invigorated through completion of privatization and stronger market competition. To foster more productive labor resource allocation across and within sectors and firms, policies need to encourage workers to adapt to changing demands for skills through on-the-job training and wider reform of the education sector. Labor market rigidities and deficiencies in tertiary and vocational education continue to act as barriers to entry and innovation. Unsurprisingly the evidence also shows that firm productivity is associated with access to quality infrastructure (roads, rail, telecommunications, power), deep and diversified financial markets, good governance and market competition.

Finally – and perhaps most importantly – it’s virtually impossible to sustain productivity improvements when wages are growing at double digit levels. When wage increases are higher than productivity growth the benefits that flow from increased productivity are lost.  The country, business, individual becomes less competitive. In a very instructional article in the Financial Times on May 30, 2008 entitled “Baltic states on course for hard landing” a Finnish electronic investor in Estonia said “Raising productivity by 10 to 15 percent a year is possible. But with wage increases at 20 percent you are facing problems”. He is now has no option but to cut his workforce.

Wage pressures in Serbia are high and we should be wary that maintained at such levels they will undermine all our efforts to modernize. So while I can assure you that there is no easy way to riches, I can also assure you that any quick, painless solution will not last for long.

Simon Gray

The World Bank country Manager in Serbia

Weekly NIN, June 6, 2008