Post-Covid productivity renaissance?
The disruptive economic shock of Covid-19 could usher in a period of stronger productivity growth rates
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The economic trajectory across advanced economies remains muted. Although economic activity picked up strongly in Q3, including in several small advanced economies, the Q4 outlook is weaker as lockdowns are re-imposed in response to surging Covid-19 cases in Europe and the US.
But it is increasingly possible to tell a more positive story about the strength of the recovery over the next 12 months and – more importantly – over the medium term.
Short-term recovery
The success in late stage trials of the Pfizer/BioNTech and Moderna vaccines, with deployment from Q4, provides confidence that day to day life will return to something closer to normal over the next 12 months.
In the meantime, government restrictions and informal social distancing will be needed to control the spread of Covid-19. These measures work, with numerous examples of sharp reductions of new cases after tighter measures were imposed (Israel, Belgium, the Netherlands). And the incoming Biden Administration will likely implement a much more effective set of measures in the US.
These current measures are also better calibrated to achieve the effective control of Covid-19 at lower economic cost than during the first lockdown.
And there is potential for economic bounce back due to pent up consumer demand as restrictions are lifted over time (as partly seen in the Q3 GDP data). This recovery process will be accelerated by unprecedented monetary and fiscal policy stimulus.
Some sectors, firms, and workers have suffered lasting damage. But macro policy across advanced economies has reduced the long-term scarring, with many firms able to expand as demand returns.
Productivity renaissance?
Over a longer time horizon of the next few years and beyond, the most important reason for a more positive assessment is the potential for a productivity renaissance in advanced economies.
Labour productivity growth has been in secular decline across advanced economies from the 1970s, despite technological progress and many policy reform attempts.
There is a broad distribution of views on whether this productivity growth trend can be reversed. Views range from Robert Gordon’s pessimistic take that we have already had the big ideas and that the world is on the flat of the productivity curve; to Erik Brynjolfsson who argues that the transformational productivity impact of new technologies like AI are on the horizon.
But a positive case can be made. The dynamics that Covid-19 is unleashing will likely accelerate investment in knowledge and technology that can drive more rapid productivity growth. Covid-19 has compressed the timelines for economic transformation, a process reflected in the pricing of technology and clean energy stocks.
There are now much sharper commercial incentives for firms to invest in technology, from automation to AI, and to re-engineer business models for a new world. As I have noted, Covid-19 is likely to advantage knowledge and technology intensive activities.
The small advanced economy experience from the mid-1990s provides an example. Governments and firms made substantial, sustained investments in human capital, R&D and capex to take advantage of new technologies and business models, and to build strong positions of competitive advantage in global markets.
An at-scale, accelerated programme of investment in technology and capital, coupled with complementary investments in human capital and innovation, could raise trend labour productivity growth sharply. This investment in intangibles as well as physical capital will be supported by very low borrowing rates.
To lift aggregate productivity growth, these investments in capital, technology, and knowledge will need to be made in sectors across the economy. It cannot rely simply on technology sectors, but needs to be a broad-based transformation from industry to services and beyond.
Governments have an important role to play. For example, substantial public sector investments in the green and digital agenda will improve national productivity over time. And policy needs to support this economic transformation, notably a focus on skills and education to support a higher skill, higher wage, higher productivity economy.
Policy also needs to ensure that the gains from a productivity renaissance are broadly shared in terms of employment and wages – not just accruing to investors and the highly-skilled. Indeed, productivity growth spiked up in some advanced economies over the past two quarters as lower productivity jobs were displaced. This is not success.
The roaring 20s
Investment at scale and on a compressed timeline in response to the severe disruption of the Covid-19 crisis may be sufficient to jolt advanced economies onto a stronger productivity growth trajectory.
Countries and firms that move most quickly and effectively to capture these emerging opportunities, and manage the accompanying risks, will out-perform. McKinsey analysis finds that firms that invest heavily in innovation through a crisis recover most strongly. This is also true at national level.
In particular, my assessment is that many small advanced economies are well-positioned for this transformation.
Despite a deeply inauspicious start, the 2020s may turn out be a decade of substantial public and private sector innovation – with higher productivity growth rates, more inclusive growth models, as well as progress on reducing emissions intensity.
Get in touch if you would like to discuss this analysis and its implications. I am also available for presentations and discussions on other global economic and political dynamics, and the implications for policymakers, firms, and investors.
Chart of the week
The 2020 edition of Landfall Strategy Group’s Economic Strength Index has just been released, an annual measure of the drivers of structural economic performance across 30 small economies that I prepare. Switzerland and Singapore top the Economic Strength Index for the second year in a row, followed by a group of small Northern European economies. These Index scores map tightly against variation in GNI per capita, providing insight into small economy performance and the policy priorities for action.
To access the full Economic Strength Index, or to discuss, please email us.
Elsewhere around the world
Four pro-democracy legislators in Hong Kong were banned from the Legislative Council, in another example of the premature ending of the ‘one country, two systems’ approach that I discussed in a recent note. In protest, 15 aligned members walked out, leaving no Opposition presence. Hong Kong also faces substantial policy challenges: this Bloomberg column (with some comments from me) notes the need for Hong Kong to tackle worsening inequality.
Small economy airlines continue to struggle. Norwegian Air has now entered bankruptcy proceedings after the Norwegian Government decided not to provide additional financing; Emirates revenue was down 75% in H1 2020, recording its first half year loss in 30 years; there have been tough negotiations with KLM pilots to unlock €3.4 billion in additional financing from the Dutch government to keep KLM (the world’s oldest commercial airline) in the air; and Singapore Airlines announced a record loss of S$2.3 billion in Q2.
In the early days of Covid-19, Austria convened a group of (mainly) small economies that had performed well in managing Covid-19 to exchange notes: Austria, Australia, New Zealand, Israel, Denmark, the Czech Republic and Greece (the so-called ‘smart seven’). It has been a mixed record since then; New Zealand, Singapore, and Australia have driven community transmission to close to zero, but Austria, the Czech Republic and Israel have had major surges – partly because of premature relaxation after the first wave. Indeed, Austria has just entered a full lockdown. Overall, however, small economies have performed relatively well in managing Covid-19. Note, for example, the case of Finland, which has the lowest number of cases in the EU.
It’s a long time since 1989, when New Zealand led the world in creating an independent central bank with a sole focus on price stability. As part of its crisis response, the Reserve Bank of New Zealand now owns 37% of outstanding government bonds up from 6% several months ago. And it is stepping up cheap loans to banks as an alternative to negative policy rates. But loose monetary policy has ignited another surge in property prices, leading to an intense debate about how the central bank should operate. A former Finance Minister has suggested direct central bank funding of strategic policy priorities (e.g. infrastructure).
Israel/UAE links continue to develop after diplomatic relations were normalised recently. Etihad has announced direct flights between Tel Aviv and Abu Dhabi, with El Al having already announced flights to Dubai. And innovation cooperation is advancing as well.
Scotland represents around 8% of full UK GDP, but Scotland is also important from a military perspective. The UK’s nuclear submarine fleet is based in Scotland, together with a strategically important air base. So increasing popular support for Scottish independence (now consistently over 50% in opinion polls) has substantial strategic implications for the UK.
Singapore is launching a TechPass visa scheme to attract top tier foreign tech professionals, as part of its drive to further strengthen Singapore’s position as a leading technology hub. It is also investing heavily to grow its digital economy, including multiple skills and education initiatives.
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