The Role of Productivity improvement

Comparative productivity statistics for six countries show that from 1960 to 1980 US productivity increases averaged only 2.7 percent and that there was an actual decline of – 0.3 percent in 1980. Japan averaged a productivity increase of 9.4 percent during the same period; France averaged 5.6 percent; and West Germany 5.4 percent. These productivity improvement differences among countries have obvious implications for global competitive advantages and disadvantages, especially when coupled with hourly wage rate differences for some industries such as the automobile and steel industries.

But does increased productivity in an industry lead to market growth, or vice versa, and ultimately to profitability? There is evidence that it does. For example, a relationship between productivity growth and output growth for a large cross-section of the US industrial portfolio during 1972 – 1976, the period chosen being one during which the United States was falling behind. In general terms, the industries with higher output growth had higher productivity growth; that is, those in the upper left hand quadrant, such as industrial chemicals, other chemicals, and beverages. Those with lower productivity changes had lower output growth, as was the case with footwear, nonferrous metals, and iron and steel.

The experience curve suggests that growth is related to productivity; therefore, it is not surprising that high or low growth relates to high or low productivity sectors. Whether productivity or growth is the primary generator is not the issue. A probable theory is that they feed on each other in a reinforcing cycle. In any case, we observe that there is a general relationship.

To carry the analysis one step further, it can also be shown that there is a general relationship between output growth and returns to stockholder’s equity. The prescription seems straightforward – growth and productivity in a reinforcing cycle lead to increased profitability. Earlier in our history, when our domestic markets were more secure and dominated the strategies of US firms, the prescription seemed to work fairly well. International competition was not a vital issue. After all, the United States was the largest world market for most products. We tended to manufacture and sell for our own large markets, and by being productive, we could compete in both domestic and international markets.

But that prescription is not sufficient for firms not sheltered from foreign competition to compete in international markets. As some experts have remarked, if one considers potential exposure to import penetration over 70 percent of our goods must now operate in an international market place. Some markets have become globalized with further product standardization and even greater emphasis on the benefits that stem from the experience curve and productivity increases.

A competitor in a given country could have significant advantages in factor costs, such as labor, materials, and energy and it could have a significant productivity advantage. Of course, the factor costs and productivity advantages can result in substantially lower manufacturing costs, all adding to the net effect of being productive within an industry. In addition, however productivity enters into the international competitive equation through international exchange rates.

A company could be moderately successful in productivity improvement and could even have some factor cost advantages, could obtain relatively low costs and large growth, and could be in a position to compete effectively with domestic rivals, but exchange rates could wipe out the advantage in international markets. To understand productivity effects in international competition, we must establish a broader framework. We must first understand long term foreign exchange rate movements.

Some Exchange rate effects:

Short term exchange rates are subject to variations that probably cannot be predicted. In any case, they do not persist long enough to be converted to strategic advantage. This does not mean that they should be ignored, for the risk involved can be balanced off through hedging in foreign exchange and other important activities designed to deal with their effects.

But long term foreign exchange rate movements balance off purchasing power differences among countries over a five to ten year period. Therefore, our ability to compete with a foreign producer depends not only on how well we do relative to that producer but also on the competition between the two economies.