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Why America is so rich
T C A Srinivasa-Raghavan |
March 14, 2003
From time to time everyone wonders why America is so rich. Mostly, the reasons are traced to its spirit of competition, attitude to risk, and its ability to pursue innovation with almost demoniac zeal.
In the end, however, how rich anyone is -- individual, company or country -- depends on how well the resources at hand are used. Endowments play a role but it is how you use them that eventually decides the outcome.
And this, says Martin Feldstein, who is one of America's most influential economists, is where the US scores over others.
In a recent paper** in which he compares productivity growth in America with Europe, he argues that it "has been growing faster in the past seven years than it did in the previous quarter century."
During the same period productivity in Europe has declined.
Between 1970 and 1995, productivity rose at an average annual rate of 1.6 per cent in the US.
Since then, it has risen by 2.6 per cent and since the third quarter of 2000, productivity growth has averaged 3.1 per cent.
In contrast, the European Commission has predicted that the annual growth of productivity in Europe until 2050 will be only half that in the US. Game, set and match to the US.
The odd feature is that in the US, in industries using IT intensively there were significant productivity gains. This was not the case in Europe where in spite of IT use, productivity gains weren't much.
Why did this happen? Because, says Feldstein, the system of incentives and institutional structures were conducive in the US but not in Europe.
There were "strong incentives for managers at all levels to make the kinds of changes that can raise productivity even if that involves personal risk and discomfort."
Unlike in Europe, in the US these incentives became much stronger during the 1990s because of IT applications and the general pressure on managers to increase profits. The sclerosis in European labour markets prevented European firms from taking advantage of the technological changes.
European managers, like Indian ones, simply could not make job changes or initiate layoffs designed to increase productivity.
Not much of this is new, however. What is new, though, is Feldstein's view of why there was so much executive 'overcompensation' in the US.
Basically, he says, "the increase in incentive compensation, tied to individual and company performance, also caused executives and lower level managers to take risks, to work harder, and to engage in the unpleasant tasks that raised productivity."
That is, if you worked hard and at things you didn't much want to, you got a lot of money. If you balked, you lost your job. It was good old Darwin all over again. The pressure came from Wall Street to raise profits. You shaped up or shipped out.
The problem, however, was that with low inflation and the new competition from domestic and foreign producers, raising revenues was not easy. So it was costs that had to be cut. And that is the way it went.
The lesson for India from all this lies in a simple fact: most of the productivity gains in the US that were made possible by IT were concentrated in white-collar jobs. Indian politicians who bleat on and on about job losses amongst 'workers' would do well to recognise this.
The blue-collar job losses, are in fact, insignificant because it is not they who would be laid off if the white collar functions were computerised. The danger to their jobs arises more from faulty policies, at which India excels.
The government, which is the largest employer of white collars, needs to recognise this for another reason as well: if IT has to really take off in India, the demand has to come from the government, as it is in China. The private sector alone cannot act as the engine.
The way it has worked in the US, says Feldstein, is that 'over the past seven years, the increased productivity has been equivalent to a 7 per cent rise in output or a 7 per cent fall in the staff needed to do the original level of work.'
Apply even half that rate to government jobs in India and see what happens to the revenue deficit.
**Why is Productivity Growing Faster? NBER Working Paper No. 9530.