Public sector productivity

Or, why it\’s right to have markets in the public services.

As Paul Krugman said, productivity isn\’t everything but in the long run it\’s pretty much everything. So these aren\’t good numbers:

The ONS calculates public service productivity by counting the number of procedures carried out in hospitals, pupils taught in schools and elderly people cared for in nursing homes (classified as “output”) as well as the number of staff employed by the state such as teachers and doctors and the equipment bought for them to do their jobs (“input”).

It found that the amount of labour and assets used by central and local government rose by an average of 3.2 per cent between 1997 and 2008, with the greatest increase in 2002.

However activity in public services grew by smaller amounts, averaging 2.9 per cent a year.

“Because inputs grew a little faster than output, productivity over the whole period fell, on average by 0.3 per cent.”

Now what we expect to see in the economy as a whole is a rise in productivity: trend appears to be about 2% for labour productivity for example, year on year, decade by decade, we get 2% more per unit of labour, measured across the economy as a whole. The other important one is total factor productivity, which is what is being measured here for public services. Not just labour, but all inputs. Not quite sure what trend is here but it\’s certainly positive.

There is one thing which also needs to be taken into account: Baumol\’s Cost Disease. We would expect services to become more expensive relative to maufactures over time because labour productivity is easier to increase in manufacturing than it is in services….yet average wages are set by average productivity across the entire economy.

Given that the private sector numbers include manufacturing the private sector numbers will likely always be better than the public sector.

However, not by all that much, given that at least half and perhaps 75% of the private sector is also services.

What we get out at the end of all of these hems and haws is that if public sector productivity is going backwards then this is making us all poorer….even, reducing wages across the economy as a whole. We wouldn\’t expect public sector productivity to increase as fast as private, this is true, but we should be expecting it to increase just the same.

All of which brings us to the policy decision we need to take in order to get public sector productivity moving in the right direction. You can see what that is by examining the bones of Krugman\’s argument here. Planned economic systems seem to be near incapable of increasing total factor productivity. As Baumol also notes, it is market systems that seem to be able to create innovation (innovation being the utilisation of inventions….that is, not making some new box that goes \”beep beep\”, but getting the beep beep box into the hands of people where it actually gets used.).

So our lesson here is that, in order to get productivity moving in the right direction we need to bring markets into the public services.

No, this doesn\’t necessarily mean capitalism, multi-nationals or Crapita. It\’s markets, competition among suppliers, whether those suppliers be sole traders, consumer owned mutuals, worker owned co-ops or whatever.

And just to bend over to be absolutely fair, yes, we can also say that markets will be wasteful. There will be duplication, waste as people negotiate. But this is a static analysis and what we want is a dynamic analysis.

So let us provide such a dynamic analysis with made up (but believable) numbers.

We spend around £100 billion on the NHS. Productivity is declining at 0.3 % a year. So after five years we\’re going to be getting 98.5% of what we get for our £100 billion today (yes, I\’m ignoring inflation, or rather assuming that there isn\’t any). After 10 years we\’re getting 97%.

Now we bring in markets and we manage to turn around that productivity number, from minus 0.3% to the 2% we expect of labour productivity as trend (no, not quite the right numbers but this is an example, a model, and I\’m allowed to do that, see, just to make the point).

After five years we\’re now getting 110% for our £100 billion…..and after 10, 121%.

But there\’s a cost of bringing markets in. The cost of having spare capacity, of negotiating, of getting the workforce of the NHS acculturated to actually thinking about prices and efficiency. Call it 10% (entirely made up, it\’s a model, capisce?) of our £100 billion, £10 billion a year.

We can see that in year 1 we\’ve only got 90% of the health treatment we would have had without markets. Bad…and static. After 5 years, our market based system has begun to nudge ahead. The 10% loss is outweighed by the 10% gain in productivity while the non market system will have slipped 1.5%. After a decade though we\’re really motoring. Our non reformed system will have slipped to 97% of output for our £100 billion while the market system will be, after out 10% of costs for markets, be producing 111%.

OK, yes, those percentages aren\’t quite correct. And you can change the numbers around as you wish, assume different levels of productivity growth, costs and so on, leading to different numbers of years that it takes for the market system to move ahead.

But this is the difference between a static and a dynamic analysis of the effects.

If it is true, as a Nobel Laureate and one of the perennial also rans both state, that it is markets, not planned systems, which are able to improve total factor productivity, and markets alone which are able to do this, then a dynamic analysis shows us that moving to a market based system (or even  a pseudo market based system) will, in time, leave us all better off even at the pain of short term costs.

And of course this is the very justfication of technocracy, of those wise and omniscient peeps in government organising things for us, isn\’t it? That our individual actions at times do not lead to a collectively optimal outcome. To reach that collective optimum our immediate instincts, immediate self-interests, need to be curbed, curtailed, so that in the long run we\’re all better off.

Like, say, a 10% hit to health care today for a system which in a decade provides 10% more for the same money….and keeps on then getting better by 2% a year forever.

Which is why we need markets, if not capitalism, in public services.

8 thoughts on “Public sector productivity”

  1. It is not just markets, but where those markets operate.

    New Labour engineered markets to operate to court the State, so you had competing providers vying for monopoly contracts. This is usually a very bad idea.

    If you have the market placed to court each individual asynchronously, then this will be infinitely better in most cases IMHO.

  2. It probably means that there are less bottlenecks.

    Perhaps there aren’t people queuing up at 5am outside the walk-in dental surgery at the Royal Hospital in Whitechapel anymore.

    Can only be a good thing.

    Tim adds: Umm, no. In theory you’re supposed to know these sorts of things, your email addy being the LSE. But the removal of bottlenecks increases, not reduces, productivity. For resources already paud for would be sitting their twiddling thei thumbs as a result of bottlenecks….waiting for people to get through the bottlenecks. Remove them and already paid for resources would be used not wasted, thus raising productivity.

  3. Umm, no.

    Think of it this way. Get a personal doctor for every person in the country. What would happen? A massive drop in productivity.

    On the other hand, health would also improve.

    No one knows where the line should be drawn.

    But looking at productivity numbers doesn’t help all that much.

    Tim adds: Erm, no. You don’t get to change your argument from “bottlenecks” to “ludicrous overprovision”.

    And looking at the productivity numbers is the only useful thing we can do. For by doing so we’re looking at both the outcome (the better health) and also the resources (the inputs) which must be used to achieve that result.

    Which is, as Krugman says, not the only thing but in the long run is pretty much the only important thing.

    Come along now, you’re at a university which is supposed to be teaching economics.

  4. The matter’s even simpler than you’ve made it, Tim.

    The eventual failure of a socialist commonwealth is preordained, simply on the basis of its inability to calculate economically, to gauge profit/loss on the basis of the value of its assets (for which there cannot be a market).

    However, this weakness is not characteristic of socialism–it’s just as true of all governments; the difference in other systems simply being in the extent to which the government engages in the provision of goods and services. More is bad, less is good–it’s that simple, as a rule of thumb.

    In the private sector, the consumer (as represented by the market) is sovereign and determines who reaps profits and who gets skunked. Government is always blind because, in the first place, they are able to foist what they (the gov’t.) wants on the consumer, to a great extent but are oblivious to the costs established by systems like civil service, which regularize similar performances requiring similar abilities–totally without regard to what the consumer may be willing to pay for those various performances.

    Private enterprise efforts are a virtual guarantee that more and more will be available at lower and lower cost. Government efforts guarantee virtually the opposite.

    But the worst part–or one of the worst parts–is that the “more and more for lower and lower” leads to dramatically increasing populations in the least-able poverty-holes as they are more easily able to survive because of the lowering of the costs of maintaining life at the near-marginal level to which they’ve been long accustomed. That’s where the most dramatic effects will be felt when those long accustomed to producing efficiently and profitably and the further accumulation of capital begin to reverse direction, starting, most likely, not with obvious unprofitability–but with the harder-to-see decumulation of capital.

    Just don’t say I didn’t tell you.

  5. Look. Bottlenecks in this case show themselves in, say, long queues. People are waiting outside a doctor’s room night and day, and he is very productive because every slot is filled.

    Now get ten more doctors in the same place. Every doctor is less productive – productivity falls.

    But the patients’ productivity rises. Instead of waiting in queues day and night, they can go and do other useful things.

    If you have trouble, think of a one lane road supporting lots of heavy traffic, and what would happen if another lane gets built.

    In this case productivity is not wholly, but largely irrelevant.

    Tim adds: No….for if we’re talking about the GP being the bottleneck then we’re saying that the other NHS resources behind that are lying unused. All of that waiting to see the GP is balanced by specialists twiddling their thumbs waiting for the patient to arrive clutching their GP letter. Increase the number of GPs, clear the bottleneck, and the productivity of those specialists goes up. Thus so does system productivity.

    Now you can say that there are no specialists in the system lying unused. That clearing the queues at the GP wouldn’t lead to greater utilistation of the specialists’ time. OK, fine, but then that is telling us that the GPs aren’t a bottleneck, isn’t it? What we’re actually saying now is that the entire system has insufficient capacity, a very different thing indeed.

  6. I was using the GP example as an illustration of one type of bottleneck, not as a description of how the entire system.

    (But you’re wrong even on the GP example. If there is 100 people for 50 slots every day at a GP, then, at most, 50 people get sent to ‘the next level’. We don’t know if the machines there are lying unused or are running at capacity. That depends on how many there were to start of with. But the GPs are still a bottleneck, and if their number increases, there is insufficient capacity at the next level because 100 people get sent there instead of 50).

    I would venture that, as you say, there is insufficient capacity, pretty much everywhere. That is why there are so many queues at many points in the system (signs of bottlenecks, or if you would prefer, insufficient capacity – buts let not argue about word usage and concentrate on the actual point i.e. why a fall in productivity may be no bad thing).

    This doesn’t have to mean that there is a next level where lots of machine are lying unused.

    I would guess that is what is going on. There have been massive new investments in labour and assets, and it has meant that doctors are twiddling their thumbs a bit more some days, but patients are being treated faster ( and perhaps more time is taken over their care).

    Productivity falls, but hey, its a price I would pay.

    Tim adds: “This doesn’t have to mean that there is a next level where lots of machine are lying unused.”

    Yes, it does. That’s what “bottleneck” means.

  7. Like I said, more productive to argue whether a fall in productivity is always a bad thing.

    You think it is, because you followed it with a statement on the virtues of free-enterprise.

    Tim adds: No, I followed it with a closely argued point about how a market based system is the only one that allows us to discover improvements in productivity. I’m absolutely certain that when I went to the LSE it was necessary to show competence in reading and parsing an argument before entry……

  8. I didn’t think I needed to spell out that I was referring to virtues of free enterprise in relation to public services.

    ‘What we get out at the end of all of these hems and haws is that if public sector productivity is going backwards then this is making us all poorer’

    Is it?

    Even the general argument from Krugman’s essay isn’t too convincing.

    He was one of the only people pushing the Young paper back then.

    Two problems with it;

    1)In the basic Solow model, we start with the assumption that any savings are invested. But in developing countries, what’s missing is ‘the ability to invest’ as Hirschman calls it. Another words, they struggle to get to that equilibrium assumption. What was remarkable about Asia was the way in which they were able to invest the savings.

    (And I would add many people disagree with his methodology full stop, and his returns to education numbers and theory are a bit suspect as well)

    2)This is graph is about Latin America, but still very interesting nonetheless. http://rodrik.typepad.com/.a/6a00d8341c891753ef01348487b65c970c-pi

    Think about what it says.

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