How relevant are targets for Scottish productivity?

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The Scottish Government has a target to be in the top quartile of OECD countries for productivity. First set in 2007, this was to be achieved by 2017.

Based upon the latest data, Scottish productivity remains over 20% below the top quartile. Despite this, the government retains an ambition to close the gap on the top performing countries.

But how meaningful or relevant is such a target? And what would be better?

Recent trends in Scottish productivity

Over the long-term, productivity is key to sustainable growth. It’s also crucial to increasing household incomes as it is by producing and selling more that firms become more profitable and can afford higher salaries.

So seeking to boost productivity is the right thing to do.

But as the chart highlights, productivity levels in Scotland have been falling recently.

Labour productivity in Scotland since 2015

Q3 Prod

Source: Scottish Government Q3 2017 Productivity Statistics

Over the longer-term, Scotland has closed the productivity gap with the UK. But much of this reflects a weakness at the UK level rather than a structural change in Scotland’s own position.

Indeed, newly revised data – which has changed the baseline for UK relative prices – now has Scotland ranked in the 3rd quartile of OECD countries. The previous data had put Scotland in the 2nd quartile.

International productivity levels 2016 (USA = 100)

Productivity ranking

Source: Scotland Performs

Overall, Scotland’s ranking has barely moved since 2000. No amount of policy announcements, action plans or strategies have altered this.

Scotland’s international ranking for productivity

Productivity rank

Source: Scotland Performs

How relevant are such rankings?

Appearing to question whether or not we want to be in the top quartile for productivity may seem slightly odd – particularly given the importance of productivity to growth.

But benchmarking ourselves to other countries implies that we want to be like them – or can be like them relatively easily.

Even a quick glance at international rankings raises questions.

We know for example, that the figures for Luxembourg and Ireland are inflated by the unique structures of their economy – features that can’t immediately be translated to Scotland.

In Ireland for example, productivity measures are skewed by the fact that Irish GDP is inflated by multinational companies booking their profits in Ireland. Last year, the Central Statistical Office of Ireland published a new estimate – a modified measure of gross national income (GNI) – which provided a more realistic picture of the Irish economy. This GNI measure shrank the size of the Irish economy by a third.

It’s not just GDP that we have to be careful of how we interpret.

In reality, there can often be a trade-off between productivity and labour market outcomes.

France for example, has higher levels of productivity than Scotland. One reason is that its firms invest more, but they do so at the expense of employing labour. As a result, people in work are well rewarded, but unemployment tends to be higher.

Of the countries ranked above Scotland for productivity, only a handful have lower unemployment rates.

Of course, we want to be like Germany – with low unemployment and high productivity – but simply comparing ourselves to countries ranked higher on one particular measure of economic performance can be misleading.

How realistic is it to close this productivity gap?

Following this, another obvious question is whether it is realistic to hope to close such a gap?

As we have seen, Scotland’s ranking has changed little since 2000.

And as a devolved administration, the Scottish Government does not have all the levers to shape economic policy.

Moreover, there are few examples of countries actually making the scale of change that the Scottish Government is aiming at.

The chart below shows how countries have fared relative to US levels of productivity over the last 20 years. A value of +5 indicates that they have improved their relative position vis-à-vis the US by 5% points.

The black line shows the approximate scale of improvement required for Scotland to meet its top quartile target.

% point change in productivity relative to the US

OECD update

Source: OECD

As the chart highlights, with the exception of Ireland, there’s little evidence of any country having made such a leap in the last 20 years (even including the EU accession countries). And the case of Ireland – as highlighted – needs to be viewed with caution.

The government have effectively set themselves a target they arguably have little prospect of achieving.

How confident can we be that we’re measuring the right thing?

A basic assumption underpinning our drive to move up the international productivity rankings is that we are measuring the right thing. But even here there are challenges.

Firstly, these targets are based upon labour productivity. Of course, what we should be most interested in is total factor productivity. That is, the productivity of not just labour but other factors of production such as how our capital stock is utilised and/or how efficiently and responsibly we are using our natural resources. The problem is that this is difficult to measure so it is ignored.

Secondly, there are major challenges in how we capture productivity improvements in the modern economy. If the justice system puts more people in prison, is that an improvement in public sector productivity? How do we measure productivity in universities or schools and hospitals? Or in the development of new apps and technologies?

This is not to say that productivity measures are redundant, but simply that the degree of uncertainty that exists around them means that changes over time and cross-country comparisons need to be looked at carefully.

Does it really matter if we set ambitious targets?

In one sense, no. Setting targets is what every government does.

On the other hand, an extraordinary amount of effort seems to go into monitoring, assessing and reporting on these targets. It’s questionable whether all that is worthwhile. It also arguably distracts from much more important debates about policy and delivery.

Even more importantly, a focus on one particular measure of the economy can lead to bad policy incentives. Some parts of our economy are naturally going to show up as being ‘less productive’ than others, simply because of i) the make-up of that sector and ii) the way we measure productivity.

Take social care. We know that more needs to be done to improve efficiency here. But even then, as a sector centred upon personal connection and interaction, it will always be ‘less productive’ according to official economic statistics than many other sectors simply because of its labour intensive nature. But do we value it less as a result? Just as there is a debate about whether or not GDP is the best measure of economic prosperity, there also needs to be an understanding that GDP per hour worked might not be the most insightful measure of ‘economic efficiency’.

So what should be done instead?

Firstly, a much greater understanding of the context in which these targets are set is needed.

Secondly, rather than focus upon analysis and re-analysis of strategies and targets, we need to get better at evaluating programmes and policies.

Ideas that look good on paper need to be backed up by hard evidence and data. Finding out what policies actually make a difference – and what don’t – will have a much greater impact on Scotland’s productivity performance than another round of target and strategy setting

March 2, 2018