Rather than thinking AI adoption could increase productivity growth globally, it would be better to focus on other direct actions policymakers can take to ensure the available resources are used more efficiently, writes Diane Coyle for the Korea Business Herald.
The economic forecasts about short-term prospects published by the International Monetary Fund tend to get the most attention: how will different economies perform this year? Will next year be better or worse than last year? But the most interesting―and discouraging―aspect of the forecasts the IMF released last month is what might happen in the longer term.
Or rather, what might not happen. For the IMF‘s World Economic Outlook focuses on what it describes as “a significant and broad-based slowdown in total factor productivity growth” over a longer period. If nothing changes in this trend, it predicts, global growth will average a whole percentage point less than its pre-Global Financial Crisis rate (of 2.8%) by the end of this decade. While that might not sound much, it is the difference between average incomes doubling about every 40 years instead of every 25 years; compound arithmetic means small differences quickly accumulate into large ones.
Productivity is the term economists use to describe the way a given amount of inputs are transformed into an increasing quantity of valuable outputs. It is the key indicator of an economy‘s long-term growth capacity. Often the measure used is labour productivity, or output per worker hour. It increases thanks to investment, as workers get more sophisticated machinery to augment their efforts; think of a construction worker using a mechanical digger instead of a spade. Total factor productivity measures output taking account of the inputs of capital equipment and materials as well. GDP growth, and people’s incomes, over lnger periods of time depend on total factor productivity growth.
So what has caused the trend in productivity growth to slow down during the past 15 years? One reason is demography, the fact that in so many countries around the world the population is ageing and the proportion of retirees to workers increasing. This is a trend it is hard for policies to reverse.
But it may be possible to tackle other causes of disappointing productivity. Investment has declined below its pre-2008 trend, reflecting businesses‘ diminished expectations of their future profitability given a weak growth outlook as well as the series of shocks that have affected the world economy. A weaker investment trend has a direct impact on labour productivity.
It also affects total factor productivity, because investment in new equipment or software and databases is the way companies start to use new technologies. And technology is ultimately the driver of prosperity. This is clear from economic history. The dawn of modern economic growth in 19th century Europe came about thanks to the technological advances of the Industrial Revolution (steam, steel, canals, rail, textiles and more), which led to a surge in industrial investment and a transformation in daily life. In the early 20th century electrification, sanitation and the internal combustion engine were key technical advances. Hopes for a technology-driven revival in productivity growth now rest on frontier technologies such as AI, implemented through new investment.
The IMF report estimates that AI adoption could increase productivity growth globally. But it would not close the gap, and there would be considerable variation between different countries. It would be a mistake to rely on technology to return growth to closer to its previous trend. AI is not a silver bullet for faster productivity growth.
Better instead to focus on other direct actions policymakers can take to ensure the available resources are used more efficiently, as there is evidence that in many countries markets are not operating well to allocate resources efficiently between companies. The gap between the productivity of the most and least productive firms has increased significantly since the early 2000s. Economic research suggests that misallocation of this kind can account for about half the recent decline in total factor productivity growth.
The more efficient allocation of resources requires dynamic markets. New firms need to be able to enter and grow, if they have better or cheaper products than incumbents, while less productive firms need to exit. Although it is tempting to see business failures as undesirable, the exit of unproductive firms is healthy for the economy as a whole. Businesses also need to be able to access enough finance to grow, which will require a well-functioning banking system and equity markets. Trade must be sufficiently open that domestic businesses have the incentive to produce high quality products for global markets. Intellectual property protection must be adequate and properly enforced.
None of this is rocket science; these supply side policies have been in the economic policy toolbox for many decades. But they require constant vigilance. For example, competition policy enforcement has been weaker in the US and other OECD (Organization for Economic Co-operation and Development) countries in the past decade or two, leading to increasing concentration in many markets and reduced rates of business entry and exit. This may be changing, in part because the dominance of giant companies in some markets ― particularly digital ― has become impossible to ignore. But as the report highlights, tougher policies are needed to encourage more dynamism and higher productivity.
Economic forecasts are not destiny: rather, they are a prediction of what will happen if current trends continue. The IMF report concludes: “Global medium-term prospects are not all doom and gloom. Resilience amid various shocks and the emerging promise of technologies such as AI could prove transformative for medium-term global growth.” But it would be a mistake to rely on technology to somehow magically return the global economy to its previous trend rate of growth. Governments cannot afford to forget the importance of the traditional structural economic policies to make markets function well, and so ensure that the resources available are being used as efficiently as possible.
Originally published by the Korea Business Herald
The views and opinions expressed in this post are those of the author(s) and not necessarily those of the Bennett Institute for Public Policy.
