Productivity and Growth

Why have some countries grown richer and others hardly grow? When observing the evolution of the GDP per capita (GDPpc) in developed countries we may wonder why have some countries grown richer and not others. In order to understand the different rhythms of economic growth we will start looking at some data on GDP growth. We use data for the case of Spain, EU the US in two periods: before financial crisis and after it. We will see that there may be a distinct engine for growth in different periods of time. Special attention is given to productivity since this is the key force for a sustained growth.

Unequal economic growth happens even among countries sharing crucial circumstances, which should invite to economic convergence. This is the case of Economic and Monetary Union, EMU, countries. Within EMU there are no barriers to trade, there is free movement of factors of production, a single currency, and all the countries share a common monetary policy lead by the European Central Bank. Joining the Eurozone (1999) brought cheap and abundant money for all the member countries, however the GDP per capita (GDPpc) growth varied seriously among them during the first decade.

During the decade 1995-2005, the average growth of Spanish economy was 3.6% (real GDP), in fact it grew above the European Union12 (Germany, Italy, France, Belgium, Luxemburg, Netherlands, Denmark, UK, Ireland, Greece, Spain and Portugal) whose average was 2.1%. This, together with a reduced growth of the population reduced the gap of Spanish GDPpc versus that of the EU12, from 76.7% in 1995, to 82.5% one decade after.

As an example, let’s take the year 2005 (three years before the financial crisis). Spain has a GDPpc that is close to 50% (30% for the EU12) of that in the US. The reasons are mainly the lower productivity, which is 30% (5% EU12) below that of the US. Moreover, in Spain they work around 8% (20% for EU12) less hours. At that time, employment is very close to that of the US, but participation rate (the number of people in the labour market in relation of the total number of working age people) is 8% below. The ratio of working age people to total population behaves better in the Spanish case.

Both Spain and EU12 are poorer than the US, until 1990. Since 1990, the causes for being poorer are different in Spain or the EU12. In the latter, those are the less quantity of hours worked, and the lower participation rate. The weakness of Spain is mainly productivity, followed by employment and participation rate, all well below the US. We can conclude that Spain is poorer than the US because less people work, and they work less and worse, and poorer than the EU12 because less people and, even working more hours, they work worse (less productivity).

From 1990 until 2005, Spain showed a positive economic growth around 3%, similar to that of the US, however with a distinct basis for growth: an increase in the use of factors of production in Spain (labour), a growing productivity in the US case. Spain grew because they hired more workers with no improvements in their productivity, more quantity of factor of production to compensate the lack of productivity. In the US, they increased the productivity of workers, so they did not need to hire more people if they were to increase production.

After the financial crisis (2008) the lower GDP growth in Spain is caused by the fact of having less people working and those are less productive. The improvement in Spanish productivity came hand in hand with the destruction of jobs, the increase of unemployment. Those workers (or sectors) with lower productivity lost their jobs, so those remaining increased the productivity per hour worked.

In summary, there are different sources for economic growth, this imply that divergent reasons explaining why a country is richer than others are. Countries can grow basically for two reasons: either they use more factors of production or those factors become more productive. The Spanish economy enjoyed a period of sustained growth from 1995 to 2007 based on extensive job creation. Simultaneously the US economy was also growing at a similar rhythm based on an increasing productivity. In the case of EU 12, with a softer growth, this was also due to productivity increases. The Spanish economy was growing faster than most of EU countries; however, productivity growth was zero. In fact, the increasing GDP was biased towards low productivity sectors (mainly construction and tourism).

For a country to enjoy a long term, and sustained, growth it needs to increase productivity. All this means that the model of growth of Spanish economy, using more factors to produce more, generates just a mid-run growth, meanwhile the US or EU can enjoy growth for a much longer period. The focus should be on how to enhance the productivity of countries.