Economic Driving Forces: Productivity, TFP, and the Shift to Services

Economic Driving Forces and Game Changers

Understanding Labor Productivity and TFP

• Employment is a major political concern, but labor productivity is also important.
• Labor productivity can be improved by the capital ratio (K/L, machinery to labor ratio), or by rises in Total Factor Productivity (TFP).
• Total Factor Productivity (TFP) is the product of improvements in technological innovation, human capital, and management competencies.

The Golden Age (1944–1970) and Subsequent Slowdown

• The **Golden Age (1944–1970)** saw many technological advances: electricity, the internal combustion engine, running water, communications, chemicals, petroleum, etc. This led to the development of knowledge-intensive branches, such as Information and Communication Technologies (ICT).
• Productivity has been increasing more slowly since the 1970s than during the Golden Age, partly due to the decline of manufacturing and the rise of services.

Labor Dynamics and the Breakdown of Wage Rules

• Union power was high starting in the late 1960s, and workers were receiving higher wages despite **lower** increases in productivity.
• The golden rule of collective bargaining, stating that “wages must keep pace with productivity,” was broken.
• Since 1974, demand could not keep pace with productivity increases in mature industries, leading to unemployment.

The Relative Decline of Industry and the Rise of Services

We have witnessed two major economic transitions: first, the shift from rural societies to national markets based on industry; and second, the shift from industry-based markets to a global market system geared toward services.

Reasons for the Decline of Industry and Growth of Services

Demand Side Factors

• Engel’s Law states that the relative amount of income an individual spends on food and industrial products declines as their income rises.

Supply Side Factors

• Productive growth in the industrial and agricultural sectors leads to higher productivity but less employment in those sectors.
• This results in services being more inflationist than industrial products. Workers in the service sector often use the manufacturing industry as a reference, obtaining higher wage increases than justified by productivity logic (according to Baumol's Cost Disease).

Measurement Challenges and Outsourcing Effects

• When output in the manufacturing and service sectors is measured at constant rather than current prices, the shift in expenditure away from manufacturing to services is not comparable to the scale of the shift in employment away from manufacturing to services.
• One additional reason for the declining industrial figures is the outsourcing of business services by manufacturing companies.