We need a new definition of productivity in an energy-constrained world economy

This post is written by Kevin Albertson, Professor of Economics at the Centre for Decent Work and Productivity, Manchester Metropolitan University Business School.

• The problem: The global economy is increasingly resource- and energy-constrained.
• Why it matters: This will have a significant impact on our material quality of life.
• The solution: A focus on increasing the productivity of energy is what is required as a first step in addressing this problem.

Productivity – not even almost everything

Labour productivity is defined as Gross Domestic Product, GDP, per hour worked. This is not, of course, an exact definition, as economists would argue productivity also relates to the output per unit of capital; however, let us take it as a working definition.

Increasing productivity may result in a decline in workers’ real quality of life.

It seems plausible that we will all be better off if there is more GDP per hour: Nobel memorial prize in economics winner Paul Krugman once speculated “Productivity isn’t everything, but, in the long run, it is almost everything. A country's ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.”

In the UK, productivity is seen as growing insufficiently and many of the UK’s socio-economic problems result from this low productivity growth rate, so we are told. We hope to convince you in the following discussion that this definition of productivity is not almost everything, it is almost nothing!

Economic growth? What economic growth?

One suitable definition of GDP is that it is a measure of the total amount of spending in the country. There are many problems with this approach. In particular: it does not account for the depletion of natural resources (e.g. gas and oil) – only the cost of their extraction – and secondly, it does not take into account the increase in debt that in recent decades has supported the growth in expenditure.

It makes little, if any, sense for government policy to be fixated on (so-called) output per worker, when there is no shortage of workers.

As the UK Office of National Statistics points out, debt as a percentage of GDP has more than doubled since the early seventies. This implies, for every £1 additional spend in the UK (i.e. GDP growth of £1), government has had to borrow nearly £2! It is not clear increasing debt-funded expenditure per hour worked is an appropriate goal of industrial policy. Once resource depletion and debt are taken into account, it is clear the UK has experienced declining economic prospects since 1978.

The downside of productivity

The other problem with productivity growth is, as we set out in chapter 3 of our recent book ‘The History and Future of Work’, increasing productivity may result in a decline in workers’ real quality of life. This is because all too often the benefits of increased productivity accrue to those with economic or political power – unless such power is balanced e.g. by unions, collective bargaining or appropriate regulation. Further, if fewer workers can produce more output, there is the potential of insufficient employment opportunities, so-called technological unemployment. This is a significant problem globally. Even before the COVID crisis it was clear that there were too few good jobs in the world for everyone to be employed.

Running on empty

It makes little, if any, sense for government policy to be fixated on (so-called) output per worker, when there is no shortage of workers – there may, of course, be localised shortages of certain types of worker, but that is a matter of training and planning ahead. The real upcoming shortage is not labour, but energy. Quite apart from the urgent need to cut back on the use of fossil fuels for ecological reasons, it is likely the era of cheap oil and gas is over.

Consider, if there were cheap and easy oil and gas reserves available, globally extractive industries would not be attempting to develop fracking and deepwater drilling. We may note that a decline in the yield on energy extraction will not be offset simply by further borrowing or even quantitative easing.

Some say the spike in energy prices will cause a re-run of the economic problems faced in the 1970s, others say we will not be so lucky this time. The oil crises of the 1970s and 1980s indicated the problems arising from the reliance on cheap fuel. However, North Sea reserves “saved” the UK economy in the 1980s (or at least postponed consideration of the underlying problems), and the implicit warnings were not heeded. Now we face a reckoning as North Sea reserves are running out. It is unlikely there will be another equivalent windfall to be spent on deferring appropriate action to reduce our dependency on cheap fuel.

The future of productivity

We have argued that the pursuit of productivity, as currently defined, may do more harm than good for the quality of life of many in the UK. The shortage we face – for the remainder of this decade at least – is a shortage of energy. It follows an appropriate definition of productivity to pursue is not national expenditure per hour worked, but real output per unit of energy use. Simple reliance on “free” markets (the supposed response to the energy shocks of the 1970s and 1980s) has not served us well – at best deferring our confronting the problem of our reliance on cheap fuels, at worst exacerbating it.

This is not to say that markets will not form part of the solution – the question is, how ought we define markets in such a way that they drive the increase in output per unit of energy input? We must also design markets to allow output to change – as energy becomes constrained, it makes sense to prioritise the necessities of life over its luxuries.

Who knows, with the right incentives, CEOs of the future may earn respect (and their salaries), not from the number of workers they have laid off in the name of efficiency, but rather by the scale of reduction in the number of kilowatt hours used in production.

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