It is important for policymakers in Pakistan to understand that how the rate of growth in productivity within an economy – which is measured by its Total Factor Productivity (TFP) is also closely linked to the growth rate of its GDP per capita. Various empirical studies have found TFP variables to be statistically significant in contributing towards economic growth and higher national output levels in the context of developing countries. An economic development strategy must therefore be focused on improving the skills of the workforce, reducing the cost of doing business and making available the resources that businesses need to compete and thrive in today’s global economy.
In their paper published in 2016, Namra Awais and Rashid Amjad (currently serving as members on the Prime Minister’s ECC) stated that in Pakistan “over the last 35 years (1980-2015) the contribution of physical capital and education remains modest and there has been a declining trend in TFP growth with the lack of sustained growth and low and declining levels of investment appear to be the most important causes of the low contribution of TFP to productivity growth.” Given the countries abysmal performance with respect to its TFP growth, the underlying root cause behind Pakistan’s sluggish economic growth must be understood.
The standard weighting of TFP is 70 percent for labour and 30 percent for capital - therefore sustained long-term economic growth comes from increases in labour productivity. The first determinant of labour productivity is human capital which is the accumulated knowledge from education and experience, skills, and expertise that the average worker in an economy possesses. Developing countries like Pakistan need to seek ways of increasing their citizens’ stock of human capital through expanding the educational attainment of their population.
Output can grow by making people themselves more productive. This may be achieved through the acquisition of skills, also referred to as human capital accumulation, which enables a person to do more using even the same amount of capital.
The government must devise programmes aimed at increasing investment in physical capital relative to total output to promote greater GDP per capita. Such policies increase the value-added per worker and seek ways of increasing their citizens’ stock of human capital through expanding the educational attainment of their population. The second factor that determines labour productivity is technological change. Technological change is a combination of invention – advances in knowledge and innovation, which is putting that advance to use in a new product or service. Technological progress, measured as changes TFP does contribute positively to per capita GDP growth.
However, technology is the systematic application of scientific or other sources of knowledge to practical tasks. A policy implication for governments in developing countries is to therefore undertake measures that combine capital, labour, and skills more efficiently, while applying new technology to knowledge.
A recent study by the BCG Henderson Institute, Boston Consulting Group found there to be a weak link between investment in technology and productivity growth… but a strong link with labour market tightness. The authors of the study conclude that technology is the spark but tight labour markets are the enabler of productivity growth.
A number of other studies provide strong evidence to back their claim. Romer (1990) develops a model in which growth is driven by technological change that arises from intentional investment decisions made by profit-maximising firms. His main conclusions are that the stock of human capital determines the rate of growth, and that having a large population is not sufficient to generate growth. Part of this balancing act is first acknowledging that human and labour capital development labour markets push productivity growth and thereby can expand an economy’s capacity. As Peter Drucker once remarked “The ultimate resource in economic development is people. It is people, not capital or raw materials that develop an economy.”
This matters because productivity, or output per input, pays for higher wages which helps distribute income fairly in an economy without infringing upon the profitability of business owners. Human capital development and labour productivity is therefore the right foundation towards long-run economic prosperity for any developing country in order to achieve inclusive and sustainable growth.
Moving forward policymakers must first ask themselves the following question - what is the calculus of innovation? The answer is that the calculus of innovation is really quite simple: Knowledge drives innovation, innovation drives productivity and productivity drives economic growth.
The writer is an economist and strategic planning expert