Why Productivity Matters

Lots is often said about GDP (Gross Domestic Product) and GDP per Capita, but when things start getting tough, suddenly governments start talking about “Productivity Growth” - so what’s the deal?

Well, it all has to do with what happens to Surplus Value in an economy.

This is about Wealth Extraction, Wealth Production, incentives, monetary policy, and ultimately inflation.

Wealth Extraction & Production

When something with real tangible benefit gets produced - that’s wealth production.

→ If you grow a tomato you produced wealth. If you sell that tomato, you produced GDP.

When someone takes a cut of the value on the way to the end consumer - that’s wealth extraction.

→ If a shop buys your tomato and sells it to someone else with a markup - that’s wealth extraction.

As can be seen from the very simple example above, some amount of wealth extraction is fundamentally necessary to the functioning of an economy. The shop provides a real service to consumers, and consumers accept that a certain amount of value being extracted is acceptable for receiving that service.

Wealth Extraction can most simply be thought of as, “Profit gained from temporarily owning something”.

Note: Many activities provide Value-Add, which is a form of wealth production, so many economic activities are a mix of both production and extraction at the same time.

Importantly, wealth production is the “real” economy. There is no other value being created - so the value of your money is tied to the amount of production. Extraction only moves value around.

How GDP is Measured

In simple terms, GDP is measured by the total value of things at the point where they reach the end-consumer.

You grow a tomato and sell for $ → someone transports that tomato for $ → someone sells that tomato for $ → final sale price = GDP

What this means is that total national GDP can be expressed as:

GDP = [Total Wealth Production] + [Total Wealth Extraction]

Since most forms of Wealth Extraction serve important functions in the economy, and the exact balance of extraction vs production can fluctuate naturally over time for lots of perfectly valid reasons, this is why GDP has often been used as the main measure. GDP tends to be a “smoother” measure of overall economic growth because it hides the balance fluctuations that usually aren’t particularly meaningful in a healthy economy.

Surplus Value

When someone has been paid for whatever work they do (extractive OR productive), and has then paid for all of the things they need to sustain their lives and livelihoods, whatever money they have leftover is Surplus Value.

If they invest that somewhere, that goes into expanding an economic function of some sort (even if that “investment” is just buying a product that improves their quality of life).

If they keep it in an account, that sits on the bank’s ledgers and supports bank activities that expand an economic function.

Unless someone is burning their excess money in a fire, surplus value will always find a way to re-invest itself somewhere in the economy and support some function in the next cycle.

So… Productivity?

When Surplus Value makes its way into Wealth Production, it naturally increases the amount of production in the economy.

When it makes its way into Wealth Extraction, the opposite naturally occurs - extraction is increased.

Productivity Growth is simply, “How much more Wealth Production happened this cycle compared to last cycle?”

However, we don’t actually have effective tools to measure Wealth Production directly… this means we’re forced to rely on Other Measures of Productivity. These measures don’t actually tell you exactly what’s going on, so you have to do a bit of guesswork and interpretation to apply them - which is why public policy is often filled with very lengthy debates about productivity.

The tools we have rely on using GDP, which means they are forced to generally assume that Productivity and Extraction are balanced in their growth. If both are in balance, then if GDP increases by 3%, the components of GDP must also have each grown by 3%.

Most of the time, this mostly works.

This is because, when Total Wealth Extraction is less than Total Wealth Production → an increase in extraction does not typically cause a decrease in production.

Where it goes wrong:

When Total Wealth Extraction is more than Total Wealth Production → then to extract more wealth, extraction must be taking from wealth that was already created in the past, since it is not possible to extract more than is produced in a given moment.

When this happens it is what we call an Extraction Economy.

You may have heard of this through phrases like, “The rich get richer and the poor get poorer.”

In a functional economy, the rich get richer, and the poor also get richer (or at least don’t get poorer). Setting aside any debate about who should receive the benefits of economic growth, an economy where the average quality of life is stable or improving is functional.

But if extraction in the current cycle is cannibalising the gains from previous cycles, then you have a problem. If this occurs it means that across the whole economy as an aggregate, you now have negative surplus value.

Remember: positive surplus value is needed for productivity growth, therefore, negative surplus value must reduce productivity…

(Since only produced value is real value, all previously extracted value still represents some amount of productivity - so even if you are extracting wealth from people who gained their wealth from extraction, that still means they must extract more from production to support themselves. As a result, extracting from past value always eventually comes out of productivity.)

If productivity is shrinking… then the real economy is also shrinking.

Productivity and GDP

“Now wait a second,” you may think. “Aren’t our Productivity Growth statistics still positive? What’s wrong?”

Well, this goes back to the inadequate measures we use to measure productivity. They’re all based on GDP.

So, here’s the thing about those measures:

  1. If GDP growth % = Productivity growth % → the economy is functional and balanced

  2. If GDP growth % < Productivity growth % → the economy is booming

  3. If GDP growth % > Productivity growth % → the economy is becoming more extractive

We never know exactly how much of GDP is extraction vs production, we cannot measure it.

But, we know when extraction is growing faster than production by whether GDP is growing faster than productivity.

If you are concerned about confounding variables, you can also use PPP GDP per Capita:

  • If PPP GDP per Capita growth % > Productivity growth % → extraction is increasing

PPP GDP per Capita accounts for the effects of migration and several other things on GDP. However, the data for PPP GDPpC can be a little volatile, so it should not be relied upon as the sole measure.

Now as mentioned, fluctuations happen, so we need to take an average over a few years at least no matter which data we use. If the average GDP growth is the same as productivity, then things are alright - but if you have a long-term average that shows extraction is growing… well then you run the risk of extraction overtaking productivity.

When is Extraction Too Much?

So, we know what happens conceptually when Total Extraction exceeds Total Production, and we also know how tell when Wealth Extraction is growing faster than Wealth Production. In a less developed nation it may be obvious when extraction dominates, but a developed modern economy is complicated, and lots of different parts of the economy can be getting worse or better simultaneously…

So, how do we reliably tell when extraction is running away with things?

One way is to detect a productivity inflection; to do this we need some data:

  1. The 10-year average annual labour productivity growth rate (%) data (10PGr), going back at least 20 years.

  2. The 20-year average annual labour productivity growth rate (%) data (20PGr), going back at least 40 years.

This data can be derived from GDP & hours worked statistics, or a GDP per hour worked Index if that data is available.

Note: If you have a GDP per hour worked Index and this index number goes down while GDP goes up → you’re already there.

Then you would use the following formulas for every year in the past 10-20 years:

  • For the 10-year average data:

    • 10PGrC = [10PGr - AVG(past 10 years of 10PGr)] / AVG(past 10 years of 10PGr)

    • (Sample Standard Deviation): 10PGrSD = s(past 10 years of 10PGr)

  • For the 20-year average data:

    • 20P-PxDiff = 20PGr - AVG(past 20 years of 20PGr)

    • 20PGrC = IF: | [20PGr - AVG(past 20 years of 20PGr)] / AVG(past 20 years of 20PGr) | > 0.1 ,
      THEN: [20PGr - AVG(past 20 years of 20PGr)] / AVG(past 20 years of 20PGr)

      • Note: We clear out <10% variances so that natural fluctuations aren’t a distraction.

    • (Sample Standard Deviation): 20PGrSD = s(past 20 years of 20PGr)

Then there are a few simple tests to determine whether extraction is approaching or beyond the critical threshold of wealth extraction exceeding wealth production:

Approaching Threshold:

  1. 10PGrC < 0 & 20PGrC < 0 → (i.e. both are negative)

  2. |10PGrC| > 10PGrSD (2+ years in a row) → (i.e. 10yr rate is trending bad)

  3. |20P-PxDiff| > 2 x 20PGrSD → (i.e. rapid departure from 20yr average)

  4. |20PGrC| > 10% AND |20PGrC| > 20PGrSD → (i.e. 20yr rate matters and is worsening faster than natural variation)

Beyond Threshold (this is now a full-fledged Extraction Economy):

  1. 10PGrC < 0 & 20PGrC < 0 → (i.e. both are negative)

  2. |10PGrC| > 2 x 10PGrSD → (i.e. 10yr rate has more than doubled natural variation)

  3. |20PGrC| > 10% AND |20PGrC| > 20PGrSD → (i.e. 20yr rate matters and is worsening faster than natural variation)

  4. |20P-PxDiff| - 20PGrSD > |20PGrC| → (ie. single year deviation from natural variation is falling faster than the 20yr rate trend)

    • Note, this last one may only happen once - but if all else is true it marks the inflection point.

The above process does not identify what the extraction mechanism is, but it reveals when it has become unsustainable.

Note: Looking at when the 10PGrC trend began going negative may be helpful for identifying the policy causes.

The Australian Example

<Data Table to be inserted here>

In Australia’s case, it can be clearly seen that the current trend towards excessive wealth extraction began in 2008, approached the threshold in 2017, and despite significant upheaval and policy during COVID, crossed the threshold into being an Extraction Economy in the 2022/2023 financial year.