Productivity and the Demand for Workers

Employers have to take account of ‘supply and demand’ in the labour market.[1]  They require suitably qualified workers and, in classical economic theory, they can afford to pay more per person if employees are more productive.  They are competing for workers from a total supply of suitably-qualified people – so they have to adjust the wages and fringe benefits that they offer, to recruit enough labour to meet their needs.

Employers’ demand for labour is determined by whether they can increase their profits by taking on more people.  This depends upon whether the total employment costs of additional sales (including fringe benefits and employment taxes), plus the cost of the supplies they need, will be matched by the selling price that they can obtain.

Average wage levels in a country reflect its average productivity, and that is no longer increasing as fast as it did in the second half of the last century.  A BBC article, UK productivity suffers worst drop in five years, quoted Paul Krugman:

“Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker”.

A country like America, for example, has high overall productivity, which lifts its average wage-levels; employees are therefore able to ask for higher wages than those in less developed countries.

Productivity is “measured by output per hour”.  It is affected by several factors:

  • New technologies such as automation, better facilities and better infrastructure can make industry more efficient – and reduce the requirement for labour.
  • Education and training (3.2.5) can make labour more productive.
  • The regulatory burden (3.3.1) can affect productivity.

Automation has the biggest impact.  A Financial Times interview, Nobel economist Angus Deaton on a year of political earthquakes, included this quotation:

“Globalisation for me seems to be not first-order harm and I find it very hard not to think about the billion people who have been dragged out of poverty as a result. I don’t think that globalisation is anywhere near the threat that robots are.”

In terms of the world economy, globalisation shifts work around – but automation reduces the total amount of work needed.  It isn’t quite as simple as that, though: Duncan Weldon’s article, Droids won’t steal your job; they could make you rich, pointed out that increased efficiency in one industry generates more wealth and thereby more demand for other jobs – though these might be in the service sector, and many such jobs are low-paid.  A bigger service sector simultaneously reduces a country’s average wage levels and its average measured productivity.



[1] Samuelson and Nordhaus explain the labour market in chapter 13 of Economics, including the impact of productivity on affordability of wages.

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