The Grey Chronicles


Business Cycle and Productivity

The Department for Business, Enterprise & Regulatory Reform [BERR]’s The 2008 Productivity and Competitiveness Indicators (2009) reports the progress on UK productivity performance, with a focus on looking at progress on the underlying drivers of productivity: Investment, Innovation, Skills, Enterprise and Competition.

The paper observes that:

“Analysis of business cycles indicates that productivity (measured in terms of output per worker) tends to decline at the bottom of the economic cycle as changes in employment tend to lag changes in output. . . [The report] provides a short assessment of the possible implications of the economic downturn on productivity and the five drivers and emphasizes what should be monitored closely, and which policy areas might require action.”

Productivity performance is measured using two main average labour productivity measures: the average output [GDP] produced per worker, and per hour worked. GDP per hour worked is the preferred measure because it takes account of variation in hours worked, due for example to differences in holiday entitlements and part-time work. However it is not measured consistently across countries, so GDP per worker tends to be used instead.

Economic theory does not provide a clear insight of the impact of the business cycle on productivity. The evidence on the impact of the business cycle on specific drivers is also mixed. The report specified the five drivers followed by the summary of findings:

Investment in physical capital is an essential determinant of economic growth and is undertaken to improve technology, productive efficiency and future capacity. Investment is driven by business strategy, cost of doing business, the quality of infrastructure, the taxation system and macroeconomic, political and policy stability.

“Theory predicts that business investment is procyclical (i.e. it declines during recessions) as a result of weaker demand, increased risk, tighter cash flow, the deteriorating quality of trade credit assets, and reduced lending by banks seeking to reduce their exposure to default. By contrast, public investment is expected to be countercyclical, (i.e. it rises during recessions) as governments seek to compensate for private sector investment weakness. Intangible investments, such as software, design, intellectual property, branding, and corporate reorganization are likely to be procyclical, although not in all cases.”

Innovation is the successful exploitation of new ideas, encompassing the implementation of new or significantly improved products, processes, marketing and organizational changes that contribute to increased productivity and competitiveness. Innovation is driven by skills acquisition, globalization, regulation, among others.

“Economic theory does not reach a strong conclusion regarding the impact of the business cycle on innovation. . . It could be expected that innovation is procyclical to the extent that it is an investment [which] depends upon the time horizon and the existence of adjustment costs. . . Some types of innovation could be countercyclical as their opportunity cost is lower when the return on production activities is lower as in a recession. Recessions could thus lead to greater involvement in innovation and reorganization activities, particularly where these are not capital intensive as these yield higher returns over a shorter period of time. This development of new technologies, products and processes then could lead to investment in new plant, equipment and production capabilities.”

Skills are important for productivity as more skills enable individuals to work more effectively within the workplace and help facilitate the introduction of new innovative ideas and practices within the production process. Skills is driven by individual’s investment, government investment and firm’s investment in skills.

“Economic theory does not generate strong implications for investment in skills, as there are two counteracting effects. Investment in skills could rise since the opportunity cost of education and training (i.e. wages) tends to decline in recessions. However, it could also fall as the ability to pay for it declines (due to large direct costs and the inability of individuals to borrow to finance education using future earnings as collateral). Lengthy periods of unemployment could also lead to deterioration in the stock of human capital and the productive capacity of the economy, which could have persistent effects into the next business cycle.”

Enterprise, the seizing of new business opportunities by both start-ups and existing firms, is an important source of productivity growth and wealth creation. Enterprise is driven by culture, knowledge and skills, access to finance, business innovation, regulatory framework,

“The impact of the business cycle on the Enterprise driver focuses on new firm formation to take advantage of market opportunities. . . Evidence on net firm formation and its determinants over the business cycle is limited . . thus [it is] difficult to predict the impact of recession on business formation and the number of enterprises. . . The economic downturn is expected to lead to a decline in the number of business start-ups due to lower demand, increased financial constraints and increased risk. However, this could be offset if those who become unemployed increasingly use self-employment as a means to remain in the labour market—there is evidence that this happened during previous recessions.”

Competition is important for productivity as a greater level of competitive intensity encourages new entry and increases the pressures on incumbent firms to improve product quality and reduce prices, as well as to develop new and innovative products and production processes. Competition is driven by barriers of entry and exit, competition framework, competition policy, corporate law and governance, and consumer activism.

“Economic theory does not generate strong conclusions regarding the impact of the business cycle on competition. Competition could increase initially due to lower demand, but could then decline in specific markets due to firm exit. . . Similarly, the theoretical implications of the business cycle on the business environment, which in turn influences market competitiveness, are not clear. Indicators of the business environment could improve in recessions, for example less congestion on roads, weaker upward pressure on wages and prices, and lower tax rates. At any rate, international differences in macroeconomic conditions could dominate changes in international measures of national competitiveness. The intensity of trade in both exports and imports will be affected, but there needn’t be any net impact on the degree of competition in the domestic economy. As far as the regulatory environment is concerned, there is no reason why this should be affected. Moreover, the competition regime has in-built flexibilities enabling account to be taken of the present difficult circumstances.”

The report’s important message:

“Recessions can lead to positive improvements in underlying productivity through a number of routes. For example, less productive firms could be eliminated during recessions, increasing average productivity in the upturn. Second, firms may invest in productivity-enhancing corporate reorganization or training during periods of slack when the opportunity cost in terms of forgone profits tends to be lower. Third, recessions increase the likelihood of bankruptcy for firms that do not prepare for the upturn by investing in this way.”

Are we prepared for these? Or should the question be: Have we prepared for these?


Department for Business, Enterprise & Regulatory Reform [BERR] (2009). The 2008 Productivity and Competitiveness Indicators. UK: Department for Business, Enterprise & Regulatory Reform [BERR], February 2009. p. 122 back to text

Disclaimer: The posts on this site does not necessarily represent any organization’s positions, strategies or opinions; and unless otherwise expressly stated, are licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 3.0 Philippines License.


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