Technological revolution will quickly affect productivity

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“It took years before computers started affecting the economy, but the current technological revolution should become visible in the statistics quicker,” believes Professor Matilde Mas.

CE Financial Observer: How do you explain the mystery of the low productivity growth in Europe and the fact that we are lagging behind the United States?

Matilde Mas: It is a fact that the United States is still the global leader in productivity in many industries, and the developed economies of Europe are experiencing a decline in productivity. However, even if we were to compare the United States with its own previous performance, there have also been some drops in productivity there, and the situation has only started to improve recently. Meanwhile, China and India are a separate story. In these countries, the rate of productivity growth is not going down, and perhaps this may be one of the reasons for Washington’s current confrontation with Beijing.

In your research you write about the low labor productivity in Europe and the possible solution in the form of investments in intangible assets. How do you define them?

To put it in the simplest terms, intangible assets are the ones that contribute to productivity growth, but are not, for example, buildings or employees, which makes them more difficult to measure. Of course, there are some intangible assets that have been recognized by the national accounts for a long time, such as the expenditures on research and development (R&D). However, I emphasize the importance of the assets that are not included in GDP statistics: the expenditures on marketing research, product design, employee training, and the adoption of a suitable organizational structure by the company. Carol Corrado argues that such investments should be included in GDP, as they contribute to the production process for a period longer than one year, which is precisely the definition of assets. There is one other important aspect of intangible assets.

Namely?

The spillover effects. The main reason why investments in the sector of information and communication technologies (ICT) have only started contributing to productivity growth since about 1995 is that from that point the existing investments in tangible assets have been supplemented by investments in intangible assets. And these intangible assets started generating positive spillover effects on the entire economy. Or, at the very least, it is beyond discussion that from a statistical point of view intangible assets have a positive impact on labor productivity and on the total factor productivity. They should therefore be included in GDP, but they are not.

Does it mean that there is no problem with a decline in productivity, but with imperfect definitions of productivity?

No. I believe that even if the definitions were different, we would still be dealing with a decline in productivity, although perhaps it would be a bit smaller. The reason for this is simple — these investments in tangible and intangible assets are not carried out simultaneously, they are not scheduled well enough to complement each other, and as a result their benefits are smaller and are appearing more slowly.

Are investments in tangible assets, such as buildings or infrastructure, still important?

Yes, they are. What is equally important is the fact that we are only worrying about the decline in labor productivity, and not about the decline in capital productivity. Meanwhile, we have not had large gains in this regard for years.

What is the reason for the low capital productivity?

I don’t know the answer for Poland, but in the case of Spain it may be due to the fact that we are much more interested in short-term benefits than in the long-term prospects. What has happened in our construction sector could serve as an example of that approach. Bad decisions concerning the scale of allocation of funds in this industry led to the development of a bubble. Right now, in the context of new technologies, many companies are also wondering whether they should already be investing, for example, in robotics or in artificial intelligence, and these are not easy decisions. After all, there are no business models and sound calculations to rely on. Additionally, most companies in Spain do not invest in expanding their employees’ competencies. Even if a company invested in, let’s say robotics, it would turn out that there are no properly trained managers and employees to work in a robotized environment. It would also likely turn out that the structure of the company itself does not fit the new investments.

In the ranking of the world’s most innovative companies done by the Boston Consulting Group the first company from Europe, Orange, is ranked 19th, while companies from USA occupy as many as 15 out of the top 18 positions. Is it possible to catch up when Europe is so far behind? Maybe Europe should simply get involved in something else than technology?

It’s worth asking whether we are talking about broadly or narrowly defined innovation. I don’t know the methodology applied in this ranking, but if it was developed solely on the basis of expenditures on R&D, then it simply has to look like that. However, if we define innovation more broadly, then it’s worth noting that the list does not include, for example, Inditex — the owner of the Zara brand. That Spanish company is one of the leaders in productivity and spends a lot on the design of its products, while the traditionally understood research and development expenditures are not treated by the company with such priority.

Does this mean that there is no problem with innovation in Europe?

The European Union does have a problem with both innovativeness and competitiveness. And this is a problem which goes beyond the best companies’ rankings. What is happening in companies at the top of the ranking is not as important as what is happening in companies that are ranked lower. In Europe, we have a group of productive companies, but their knowledge and experience do not change the entire economy, and do not rub off on the other companies. In the United States, these spillover effects are much stronger.

So what has to happen to create next Facebook or next Amazon in Europe?

In order to have companies of this importance in the future, we have to change the entire philosophy of financing new business ventures. Most investments in Europe depend on the banking system, and banks, by their very nature, ask for tangible collateral, such as buildings or machines. They are not interested in the idea behind a promising start-up, no matter how potentially profitable it is. Meanwhile, in the Unites States angel investors are more willing to provide funding for interesting ideas, because they understand that higher profits are impossible without a higher risk.

My next observation is that in Europe we don’t have the same relationship between business and science as they have in the US. Let’s take, for example, the Silicon Valley and the Stanford University. Cooperation is very close there, and it benefits both sides. In Europe, it’s too complicated. We have too much bureaucracy and things are happening too slowly. Of course this is changing, but it still isn’t enough.

You quoted Robert Solow’s remark from 1987: “You can see the computer age everywhere but in the productivity statistics”. Have we been able to overcome this paradox and are the investments in ICT contributing to the economy without such a time lag?

Yes, the ICT sector, which blends well with intangible assets, proved to be fundamental to the productivity growth in the years 1995-2008. This is clearly visible in the statistics. Of course, right now another revolution is taking place, which would not exist without the previous one. After all, artificial intelligence or machine learning would not be possible without computers. Thus far, it was mainly the computer revolution that has been contributing to growth, but now it’s time to take the next step.

So when will the current wave of technology — artificial intelligence, Internet of Things, robotics — start showing up in productivity statistics?

This is just my intuition, but I believe that it will happen faster than we think. History provides justification for such optimism. Solow described his paradox in 1987, and just a few years later, in 1995, a real productivity boom began. Right now we have a period of certain political instability in the world and investors are worried. But if we could tune these factors out, then the new technological revolution would arrive fairly quickly.

Matilde Mas is Professor of Economic Analysis at the University of Valencia, director of the DICTA Project (Data for European ICT Industries Analysis). She was a guest at the Poland’s central bank, NBP conference “The Mystery of Low Productivity Growth in Europe” (read more about the conference)

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