Economic Growth: Standard of living

Relationship between productivity and unemployment

In the previous section we learned that increases in productivity allow a given amount of labor to produce a greater amount of output than was possible before the productivity increase. Popular wisdom dictates that increases in productivity thus reduce the number of jobs available, because less labor is required to produce the same amount of output. Fortunately, this is not the case suggested by the historical economic data. Rather, increased productivity seems to help the economy overall to a much greater extent than it hurts workers, especially in the long run.

A historical example will serve to demonstrate this. Since the early 20th century, there has been an over 1000% increase in output per hour in the US. This means that, on average, workers today can produce more than 10 times more than what workers, on average, could produce around the turn of the century. With productivity increases this high, it seems that unemployment should be very high, too, as all of the goods and services used in the early 1900's can be produced now by a much smaller workforce.

But, as productivity increases, so do the number of products and markets available. Similarly, as products become less expensive, due to more efficient production methods, the quantity demanded for some of those products also increases. Overall, in the long run, increases in productivity are offset by increases in demand, so those jobs are not lost.

Costs of lagging productivity

We just demonstrated how increases in productivity do not necessarily result in a rise in unemployment. But what is the other side of this coin? That is, what are the effects of lagging productivity? In general, a country that lags in productivity will have both lower wages and lower living standards than a country with higher productivity.

This assumption is based on the idea that all economies trade on the open market. If a country that lags in productivity produces a good to sell on the international market, it must price the good at the same level that more productive countries. In this case, the only way for the lagging country to produce the good at a low price is to pay labor a low wage. Thus, if labor receives a low wage, the workers are unable to provide or enjoy a high standard of living.

Let's work this out through an example. Say that there is an international market for widgets. The going price is $5 per widget. Most productive countries are able to produce widgets and sell them for this price. One country, which is lagging in productivity, can only produce widgets at half the speed of the other countries. But, because the lagging country is only able to sell widgets at $5 each, it must reduce its costs of production. Since labor is the only cost that can be changed, as the machines are paid for and their maintenance cannot be put off, workers are paid less to make the country that lags in productivity competitive in the international marketplace.

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