Labour productivity is arguably one of the most important economic indicators that we have. It measures how much economic output each worker can produce over a period of time, usually taken to be a year. For a country, improvement in labour productivity means more goods and services can be produced with less workers and this underpins the potential for economic growth. For workers, increased productivity is the most important source of higher income and improvement in the standard of living. Over the long-term, sustained economic development hinges on the continued growth of labour productivity.
In this issue brief, we trace the changes in labour productivity in Malaysia between 1985 and 2016 to provide a broad overview of its development over three decades and across a generation of Malaysians. We summarise our findings into three salient facts.
Fact 1: Labour productivity is two-and-a-half times higher compared to three decades ago
The overall level of labour productivity increased by almost two-and-a-half-fold compared to three decades ago. Measured in 2010 prices, labour productivity level was around RM28,000 per worker in 1985. In 2016, it increased to RM71,000 per worker. This increase was anchored by the rise in labour productivity in the manufacturing sector, which increased by nearly three-and-a-half times between 2016 and 1985. Other sectors followed1 - the services sector increased by about two-and-a-half times and the agriculture sector, two times. The construction sector, however, only increased by 0.5 times of 1985 levels, with productivity even decreasing in 2005.
This trend coincided with the structural change that occurred in the Malaysian economy, with the rapid industrialisation in the late 1980s and the modernisation of the services sector since the turn of the millennium. As Figure 1 clearly illustrates, where once productivity level was similar across major economic sectors, the manufacturing sector has outpaced all others since. This contrasts with the performance of the construction industry, which did not see significant improvement of labour productivity. Similarly, improvements in labour productivity of the agriculture sector has also lagged behind, gradually overtaken by the improvement in the services sector.
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Fact 2: But labour productivity growth is now only two-thirds of what it was
The growth in labour productivity, however, has slowed down substantially in the past three decades. This slowdown was especially steep in the most recent period. Between 1985 and 1996, labour productivity on average grew by 3.9 per cent per year. This fell to 3.6 per cent for the period between 2000 and 2007 and 2.5 per cent for the period between 2011 and 20162.
One helpful approach to examine the decline in labour productivity growth is through a shift-share analysis3. This approach decomposes overall labour productivity growth into two components – changes in labour productivity growth within the economic sectors (within effect), and the shift of employment towards sectors with different productivity levels or growth (shift effects).
As shown in Figure 2, the decline in annual labour productivity growth during the three periods were predominantly due to within effect. Looking at the within effect for each economic sector, it is found that the decline in labour productivity is not isolated to any particular sectors. This was particularly stark in the most recent period between 2011 and 2016 in which the calculated within effect of the agriculture sector fell by 75 per cent from that experienced in 1985-1996, while that of the manufacturing and services sector fell by 44 per cent and 40 per cent respectively. These three major economic sectors employ 90 per cent of all workers in the Malaysian economy.
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Fact 3: Labour share is gradually shifting towards less productive sectors since 2000
While shift effects did not significantly affect overall labour productivity growth on a yearly basis, it has consistently been negative. Over many years, the accumulated impact of this could be significant. Indeed, labour share has been gradually shifting into less productive sectors since 2000 (Figure 3). Between 1985 and 1996, the manufacturing sector which had higher level of labour productivity compared to other sectors, saw an increase in overall labour share, from 15 per cent share of total employment in 1985 to a peak of 23 per cent in 2000. Since then, however, the labour share of manufacturing sector began to decline. It currently stands at 17 per cent.
The gradual shift of the structure of the economy towards less productive sectors could have significant long-term implications on the economic development of the country. As discussed in a previous discussion paper4, this trend of deindustrialisation could reduce growth potential and upset our path towards becoming a developed country. This is because manufacturing, besides being more productive, is also typically the most technologically dynamic sector, exhibiting unconditional convergence to global economic frontier.
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Turning the tides of low productivity growth
If the current trajectory of broad-based slowing labour productivity growth and productivity-reducing structural shift is not reversed, the economic development of Malaysia could be at significant risk going forward. It is important to note, however, that this situation is not particularly unique to Malaysia - globally, for both advanced and emerging economies, the trend of falling labour productivity growth for the past decade has been identified to be one of the most pressing economic challenges of the current period. If weak productivity growth is to persist for another decade, global living standards could be seriously undermined, and economic and social stability in many countries could be imperiled5.
Recognising the challenge of low productivity growth, the recently launched National Productivity Blueprint by the Government is both timely and highly consequential. By providing clear strategies to improve productivity from the national level to the enterprise level – including through harnessing new technologies – it can, with effective implementation, steer the country back to the path of high productivity growth for the economy and better living standards for all Malaysians.
