ECN105 Contemporary Economic Issues

Lecture 5

Technological Progress, Productivity and Living Standards

…. The UK productivity puzzle revisited…
Lecture plan
• Creative Destruction
• Technological Progress
• Jobs creation and destruction
• Technological change and the adjustment to the long run equilibrium
• Technological progress and income distribution
• The UK Productivity Experience and Puzzle….
So, what determines the long-run expansion of the economy?
 Technological Progress
Creative Destruction
• Joseph Schumpeter’s name for the process by which old technologies and the
firms that do not adapt are swept away by the new, because they cannot
compete in the market
• Leads to sustained increases in living standards on average because technological
progress and the accumulation of capital goods are complementary
• New technologies require new machines: The accumulation of capital goods is a necessary
condition for the advance of technology
• Technological advance to sustain the process of capital goods accumulation: It means that
the introduction of increasingly capital-intensive methods of production continues to be
profitable
The economy’s production function and technological progress
 Marginal product of
capital at  A =
A Δ(Y/worker)
Δ(K/worker)

Production function (after

Output per worker, $US thousands

technological progress)
22.5 A
C Production function
Labour Productivity

15
B

Diminishing marginal product of capital

Average product
Technological progress
of capital, Y/K
0
• Better management of resources
• Information Technology revolution
0 20 30
• Robotisation?
Capital equipment per worker, $US thousands

Capital Intensity
Some evidence about capital accumulation and technological progress
 Productivity growth has reduced labour
GDP per w orker (1985 PPP $)

input per unit of output: the fear of the

“Luddites” and the forecasts of the ‘end of
US (1800-1990)
40,000 work’ authors was that this would cause
permanent job loss which has not been the
35,000

US,
case
30,000 1953 UK (1760-1990)

25,000 Taiwan
Japan (1870-1990) The historical paths traced out by these
UK,
1973 (1901-1990) economies are not curved like the single
20,000
UK,
production function curve we saw before.
15,000
1910 This is because they experienced a
UK, US, 1910 combination of capital accumu­lation and
10,000 1760
technological progress
5,000 India (1860-1990)
US, 1800
0
0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000

Capital per worker (1985 PPP $)

Summary

• Technological progress shifts the production function up: It is stimulated by the

prospect of innovation rents
• This offset the diminishing marginal returns to capital: Capital productivity,
measured by the slope of a ray from the origin, has remained roughly constant
over time in the technology leaders
• Technological progress played a crucial role in preventing diminishing returns
from ending the long-run improvement in living standards resulting from the
accumulation of capital goods.
Jobs creation and destruction
 Job creation and destruction

• Labour-saving technological progress allows more outputs to be produced with a

given amount of labour, and it also contributes to the expansion of production
• By incentivizing investment, it compensates for some of the jobs it has destroyed,
and may even create more jobs than previously existed
• When more jobs are created than destroyed in a given year, employment increases
• When more jobs are destroyed than created, employment decreases
• Stock Variable: the number of unemployed people is a stock variable
• Flow Variable: the unemployment rate, the change in the stock of unemployed
people, is a flow variable
 Job destruction, job creation, and net employment across countries
Percentage of employment
Job destruction Job creation Net employment change
18

16

14

12

10

-2
Germany (77-99) France (99-00) United States (88- Chile (79-99) United Kingdom (80- Brazil (96-01)
97) 98)
What historical evidence tells us is that:

• Contrary to the fears of the “Luddites”, the constant increase in the amount produced in
an hour of work has not resulted in ever-increasing unemployment
• It is wages that on average have risen, not unemployment
• In many countries, the combination of technological progress and investment that raises
the capital stock roughly doubled the productivity of labour each generation
• However the ‘Luddites’ were right to be concerned about the hardships experienced by
those thrown out of work
• What many tend to miss is that the additional profits made possible by the introduction
of the new technologies provided a kind of self-corrective: additional investments that
would sooner or later result in the creation of new jobs
Technological Change, Productivity and Long-run Employment
 Technological Change, Productivity and Long-run Employment

Output per worker

(new technology)
Output per worker
(old technology) Wage-setting curve

Real wage (new)

B Price-setting curve
Real wage

(new technology)
A Price-setting curve
Real wage (old)
(old technology)

Employment, N
6% unemployment rate 4% unemployment rate
(Initial long-run unemployment rate) (New long-run unemployment rate)
How does the economy adjust to the new equilibrium?
 New technology shifts up output per
worker and the price-setting curve
Output per worker
(new technology)
Output per worker AD: Introduction of new technology
(old technology) Wage-setting curve leads to a rise in unemployment
B Price-setting curve
Real wage (new) DE: High profits encourage new firms
Real wage

(new technology) to enter

D A Price-setting curve
Real wage (old)
E (old technology) EB: Lower unemployment leads to
rising real wages

B: The new long-run rate of

unemployment is 4%

Employment, N
6% unemployment rate 4% unemployment rate
(Long-run unemployment rate) (New long-run unemployment rate)

© The CORE Project 2015

 • Is the movement to the new equilibrium a win-
win journey?
• Well…. Only if you compare the start and end
points or have a sufficiently long time horizon
Output per worker
(new technology) • The time between the introduction of new
Output per worker technology and the new long-run equilibrium is
(old technology) Wage-setting curve usually measured in years or even decades, not
B Price-setting curve weeks or months
Real wage (new)
Real wage

(new technology)
D A Price-setting curve
• Younger workers might have more to gain from
Real wage (old)
E (old technology) the eventual higher wages and employment, but
older workers might never experience the
outcome at B
• Also we assumed that the real wage did not
decline in the short run. But firms could lower
the real wage so that it lies on the wage-setting
Employment, N
curve at the new level of unemployment. This is
6% unemployment rate 4% unemployment rate
(Long-run unemployment rate) (New long-run unemployment rate) more likely to happen if the new investment that
would take the economy to point E is slow in
arriving. In that case, wages may fall under the
pressure of greater unemployment before
employment adjusts upwards.
 The role of institutions
• Public policies, trade union, and employer association practices can alter the size of this employment and
wage adjustment process
• Government policy can help reallocate workers to new firms and sectors by providing job-matching and
retraining services, and by providing generous but time-limited unemployment benefits. This helps workers
released from failing firms to move quickly to better ones
• The size of these adjustment gaps also depends on institutions and policies that could ease or hamper the
creation of jobs in new sectors
• If the wage is below the price-setting curve, profits are sufficient to create new investment and form new
firms. This is part of the process of adjusting to creative destruction
• Some countries have well-designed product-market regulation and competition policy that make it easier
to start a new business
• In others, incumbent businesses have succeeded in making it difficult for new firms to enter, which slows
or even prevents the economy moving to point B
 The role of institutions

• Economies differ greatly in the extent to which their policies, culture, and institutions allow
consumption smoothing
• In those that do this well, resistance to the creative-destructive forces of technological progress is likely
to be low
• In those that do not, owners and employees alike will try to find ways to resist (or halt) the process of
creative destruction, preferring to defend their firm’s assets and existing jobs.
• The attitude of unions to the process of job destruction and creation is an example
• In countries with adequate consumption-smoothing opportunities, trade unions tend not to insist
on a worker’s right to keep a particular job. Instead they demand adequate new job opportunities,
and support in searching and training for new work
• In other countries, unions and government policy seek to protect the status quo matching of
workers to jobs, this may be harmful to labour market performance by lengthening the adjusting
time for the economy and slowing the rate of technical progress
Effects of a new technology on inequality in the short and long run
 Unemployment before the new technology is introduced
The economy starts in long-run equilibrium before the new
technology, with a share A of the population being unemployed
100
Cumulative share of income (%)

The implementation of the new technology

This displaces some workers from their jobs so that unemployment
now increases to D. Assuming that wages remain the same for the
remaining workers, and given that output per worker has risen,
wages as a share of output declines

Economic profits are high

Over time, new firms will be attracted to the economy and
investment will rise, so existing firms will expand. Unemployment
eventually falls to the level shown by point B, the new long-run
equilibrium.
0
0 BA D
Unemployed Workers Employers

Cumulative share of the population

from lowest to highest income (%)
Talking about productivity…. Some evidence about UK productivity,
wages and unemployment… back to the productivity puzzle…
 UK Productivity - Quarterly Output per hour worked (2016 = 100)
120.0

100.0
Output per hour worked (index, 2016 = 100)

Productivity gap
80.0

60.0

40.0

20.0

0.0
1971 Q1 1973 Q2 1975 Q3 1977 Q4 1980 Q1 1982 Q2 1984 Q3 1986 Q4 1989 Q1 1991 Q2 1993 Q3 1995 Q4 1998 Q1 2000 Q2 2002 Q3 2004 Q4 2007 Q1 2009 Q2 2011 Q3 2013 Q4 2016 Q1 2018 Q2
 UK output per hour worked, real wage and unemployment
120.0 14.0

12.0
100.0
output per worker and real wage index (2016=100)

10.0
80.0

8.0

unemployment rate
60.0

6.0

40.0
4.0

20.0
2.0

0.0 0.0
71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18
19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20

Output per hour worked Real wage Unemployment rate

 UK Output per Hour: Manufacturing and Services
110

100

90

80
Index

70

60

50

40

30
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

manufacturing Services
 G7 Countries Productivity
115

110

105
Constant Prices GDP per hour worked (index)

100

95

90

85

80
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Canada France Germany Italy Japan UK United States

Question: what are the reasons for the sluggish UK productivity?

Answer in next week’s class!

Next Week

Class: Investigation of the UK Productivity Puzzle

Lecture: Income distribution according to Thomas Piketty
Readings

Econ CORE – Unit 16.1, 16.2, 16.5-16.8