Labour productivity in Finland’s national economy has been stagnating at the 2007 level for more than a decade. How is the development of labour productivity affected by resource allocation and structural changes in different sectors? According to a study published on 8 December, there is room for improvement when it comes to resource allocation, but the strongest factor behind productivity growth is the favourable development of individual businesses.
The favourable development of productivity is the most important factor for long-term economic growth, which is why research literature has long tried to identify the sources of productivity growth. Effective allocation of labour and capital is one of the key questions in economics, and research has sought solutions to the causes and consequences of inefficient allocation.
A new study “Labor productivity and reallocation in Finland 2000–2018” reveals that the reallocation of resources has failed to promote productivity growth in the Finnish business sector. The study examines the impacts of the allocation of labour and capital and structural changes in various sectors on the development of labour productivity in Finland’s manufacturing and service sectors, information and communication technology industry, and the business sector as a whole in 2000-2018.
Further improvements are needed when it comes to resource allocation, says Chief Research Scientist Terhi Maczulskij from the Research Institute of the Finnish Economy ETLA, who was responsible for the project.
– While the role of resources reallocation in productivity has increased slightly over time, there is still plenty of room for improvement. Inefficient allocation of inputs between sectors also weakens productivity growth in the business sector as a whole, says Maczulskij.
The study revealed differences between the sectors, but also several similarities. Favourable development within individual businesses is the main driver of productivity, especially during an economic upturn. Most of the productivity growth observed in the study took place within firms with ongoing operations, where reallocation has clearly played a secondary role.
During a recession, however, the reallocation of inputs between firms with ongoing operations is highlighted, which shows that creative destruction plays a stronger role. Creative destruction itself is an important mechanism for productivity growth, whereby old businesses, products and occupations disappear, making way for new, better and more productive ones.
– It should also be noted that in the ICT sector, the reallocation of labour and capital has actually had significant negative impacts on productivity growth. This may be explained by the fact that some companies in the sector invest heavily and grow their size before they become more productive, says ETLA Researcher Paolo Fornaro.
The study was conducted by the Research Institute of the Finnish Economy ETLA and Aalto University. The report is part of the implementation of the 2021 Government plan for analysis, assessment and research and serves the needs of the Economic Council in particular.