# Intrinsic limits to labor productivity

![Image credits : Eduaid.sg](https://2729961169-files.gitbook.io/~/files/v0/b/gitbook-legacy-files/o/assets%2F-MFJ5MsKlTDaW3Iq3QZH%2F-MHPgUYCSJQxEAK8TYUc%2F-MHPlXTJU5Dain3xuW4W%2Fimage.png?alt=media\&token=211a3a58-64b1-483f-a849-995711422e44)

The long term trends of decelerating income growth in Singapore can be attributed to a corresponding drop in labor productivity growth rates (MTI, 2016 Productivity and Wage Growth in Singapore) and are consistent with the general observed decline in productivity growth in the transition to the services economy (OECD, 2000).&#x20;

![Figure 5.9 : World Bank, OECD data % GDP per hour worked and % GDP from services](https://lh3.googleusercontent.com/p7XJI3zxUOkDBG4y1CDWAHhaGl-Uwb-2zOPGExqHnD4cW-7IYmIoQSA5U_Clw2ixRh8COecAoellFwBXnmzwY7MzyAkUpqizeWvxtZi1e6u7gGYLmQPYRgAIqfxLIecNzpLhl0Ni)

The data in Figure 5.9 is generated from a query of two data sources \[1] OECD, GDP per hr worked and \[2] World bank, GDP % services.  First, data points were selected for each country for 3 time periods - 1990, 2000 and 2010. Next a query was created joining the two tables by matching the key pair (country name, year) and non-matching rows dropped. The query result is a table of GDP per hr worked and % services for select OECD countries and 3 different years.

Compared to manufacturing, there are limits to productivity growth in the service economy (OECD, 2000; OECD, 2018).  Four barriers to productivity growth in the services economy include the measurement ambiguity, value of social contact, Baumol’s cost disease and free digital services.  The evidence of the relationship of labor productivity and services can be seen in Figure 5.9.  During the period 1990-2010 for multiple OECD countries labor productivity is lower for countries with higher services as % of GDP. Presented here are four explanations for the  barriers to productivity growth in the services economy - measurement ambiguity, value of social contact, Baumol’s cost disease and free digital services.

Intrinsic limits to labor productivity growth

1. [Measurement ambiguity](#measurement-ambiguity)
2. [Value of social contact](#value-of-social-contact)
3. [Baumol's cost disease](#baumols-cost-disease)
4. [Free digital services](#free-digital-services)

## Measurement ambiguity

The service sectors face challenges in measuring quality improvements in contrast to measuring improvements in manufacturing productivity, which have a relatively less ambiguous standard measurement of output.  In services such as consulting or media it is a challenge to define a standard unit of measure to consistently separate quantity from sales volume (OECD, 2000 OECD, 2018). &#x20;

## Value of social contact

The second challenge for productivity is for services where the value of the experience is directly related to the time spent by the person performing the work such as performing arts or involving social contact such as with a physician, consultant or caretaker.  Industries in essential services that have high social contact - healthcare, education, public administration and law enforcement are known to have low productivity growth rates (OECD, 2018).  &#x20;

## Baumol’s cost disease

A third challenge is Baumol’s cost disease which states that in the long run those industries with the high resistance to productivity improvements and low elasticity of demand tend to represent a larger share of the economy.  The costs of these services increase relative to others and aggregate productivity slows as these industries take up a larger share of the economy (Nordhaus, 2006).  As it is explained by Baumol and Nordhaus, the reason for the increase in relative prices is as follows. When there are two types of services in an economy - one which resists productivity growth and the other which is readily improved such as manufacturing - the higher incomes from the high productivity industry will tend to raise the cost of labor overall, but for the productivity resistant industry the only response available is either to decrease demand or to increase costs.  If the lower productivity industry is also inelastic which is the case for healthcare and education - the costs in these industries tend to inflate over time faster than other basic goods in industrialized industries. Empirically this prediction matches observed reality in developing countries in transition to the service economy (Nordhaus, 2006).

## Free digital services

&#x20;A feature of the modern global internet is that it is collectively owned in the public space. Consequently there are low barriers to releasing and distributing free knowledge content.  A number of industries such as music and entertainment have been completely disrupted and no longer have the market share they once had as much of the content is now available free or very cheap. Similarly wikipedia and other knowledge based products and services are produced and available commonly and for free such that no single company or private entity can monetize into revenue and profit.  While the economy as a whole is generating new knowledge, some of this value is not captured as income for any entity. The potential for new publicly available free knowledge based resources can be competitive with what is currently owned privately. As knowledge takes up a larger share of total economic activity and services so long as the internet retains the feature of free public access this could result in an observed decline in the growth of revenue-based measures of economic activity such as GDP and labor productivity (OECD, 2018).<br>
