Increasing productivity crucial for ageing society

If the labour supply in the Netherlands stops growing due to an ageing population and restrictions on immigration, the only option left to continue growing in the future is to increase labour productivity.  Without productivity growth, the Netherlands could fall into a negative spiral. Investing in the quality of education is therefore essential, says PwC chief economist Barbara Baarsma.   

Education is the most important factor behind labour productivity growth. This is evident from research we recently conducted at PwC. This is particularly important for the Netherlands, because we face a ‘productivity paradox’: the level of labour productivity is high, but growth is relatively low. Other, comparable countries, such as Switzerland, Denmark, Sweden or Germany, have higher growth rates. Moreover, Dutch productivity growth of 5.3 per cent between 2012 and 2022 is well below the EU average of 9.6 per cent.   

This difference becomes extra relevant if we consider that the Netherlands is facing a widespread labour shortage. If there is not enough supply of workers and the productivity of the employed does not increase enough to compensate for the reduced growth or even decline in labour supply, the future does not look bright. Other, better-performing countries, such as Denmark and Switzerland, may become more attractive for companies to do business. Moreover, prosperity will grow faster in these countries. Economic growth is not a goal, but a means to fill the treasury. The space that growth provides to public finances can be used to invest in broad welfare. Think of the accessibility of healthcare, the modernisation of our defence and the energy transition.

Factors determining level of labour productivity

For us, the still-unsolved productivity paradox prompted us to investigate what factors determine variation in labour productivity. Following the methodology of a World Bank research paper¹, we measured the relative importance of four factors in explaining productivity: market efficiency, quality of institutions, education, and innovation (in the appendix we explain how these factors are measured). We focus on a sub selection of 24 EU and OECD countries², since these are all prosperous countries that are more comparable to the Netherlands.

Quantifying the impact that each of the four factors might have on productivity is notoriously hard. Labour productivity is measured as GDP per hour worked, but the level of GDP also affects the amount of innovation, for instance, which can determine productivity. Hence, it is hard to draw a clear link between productivity and its determining factors. Moreover, these factors are often interdependent. Our analysis is a way to deal with this issue.

Education is the most dominant factor behind productivity growth

Our findings suggest that, in the years 2015-2020, education is the factor that is the most closely linked to labour productivity growth (figure 1)³⁴ This, in turn, means that countries that invested more in education (as a percentage of GDP), those that performed better in the PISA test, and those with higher levels of educational attainment observed higher productivity growth rates. Workers with more skills are evidently able to produce at faster rates and in larger volumes. Education and innovation also go hand in hand, since workers with better digital and other skills are better able to adapt to new technologies. However, a better educated workforce can impact society positively in many other ways⁵.

Netherlands scores poorly in international PISA test and invests relatively little 

Concerns about PISA sample adequacy notwithstanding⁶, among a selection of comparison countries, the Netherlands reported the largest decrease in average PISA test scores since 2003, as well as the second-lowest level of education expenditure (as a percentage of GDP). Education expenditure, through better teachers⁷, for instance, can certainly improve student performance⁸. Because we only look until 2020, the particularly negative effects of the 2022 PISA score are not yet felt in the analysis. These findings are particularly alarming because education appears to play such a major role in productivity development.

Pressure on talent pool quality bad for business climate

If it is indeed true that the Dutch schooling system leads to poorer educational performance, this can place a large strain on the quality of the talent pool that is accessible to Dutch companies. If the latter are not able to find skilled workers, they might decide to re-locate or expand their operations abroad.

Labour productivity growth is crucial for economic strategy of ageing societies

Education is not the only determining factor of productivity⁹. Innovation, institutions and market efficiency are also important, although they determine a smaller part of productivity growth. It is important to know what drives productivity, as its growth is a critical component in the economic strategy of ageing societies, like the Netherlands. As societies age, the ratio of working-age individuals to retirees diminishes, and increasing productivity growth becomes essential to mitigate this. In this context, enhanced productivity can maintain, if not elevate, economic output and living standards, despite demographic shifts. It is imperative to invest in all 4 of the previously mentioned factors to empower the remaining workforce to be more efficient.

_{¹ Kim, Y. E., & Loayza, N. (2019). Productivity growth: Patterns and determinants across the world. World Bank Policy Research Working Paper, (8852). These authors measure the relative importance of 5 factors. Because of lack of data, we did not include the fifth, infrastructure. Wegens gebrek aan gegevens hebben we de vijfde factor, infrastructuur, niet opgenomen.
² Austria, Belgium, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Italy, Latvia, Lithuania, Luxembourg, Netherlands, Poland, Portugal, Slovakia, Slovenia, Spain, Sweden, Switzerland, UK and USA.
³ Our model explains around 32% of the variance in labour productivity growth. This is justifiable as many relevant country-specific factors are hard to measure (such as work culture, or wellbeing) and hence excluded from this analysis. The graph depicts the relative contributions of each factor to productivity growth variance, excluding the contributions of lagged Labour productivity level (by 5 years) and year dummies. Innovation and Education are modelled as lagged variables.
⁴ Besides education, we include market efficiency, since the extent to which markets are efficient (through competition) determines how well firms allocate resources and efficient markets stimulate productivity; institutions, which can also create this competitive environment, by protecting property rights effectively while ensuring that the right incentives are put in place, and innovation, which by contributing to the creation of new technologies that complete routine and repetitive tasks, leaves space for workers to focus on more complex or higher-yield tasks, for instance.
⁵ Huang, J., Van den Brink, H. M., & Groot, W. (2009). A meta-analysis of the effect of education on social capital. Economics of education review, 28(4), 454-464.
⁶ Fairley, K. (2024), Trek niet te snel conclusies over de beroerde leesprestaties van Nederlandse jongeren, Volkskrant, 5 maart. [In Dutch]  https://www.volkskrant.nl/columns-opinie/opinie-trek-niet-te-snel-conclusies-over-de-beroerde-leesprestaties-van-nederlandse-jongeren~bb90126b/
⁷ Belmonte, A., Bove, V., D’Inverno, G., & Modica, M. (2020). School infrastructure spending and educational outcomes: Evidence from the 2012 earthquake in Northern Italy. Economics of Education Review, 75, 101951.
⁸ Card, D., & Krueger, A. B. (1996). School resources and student outcomes: An overview of the literature and new evidence from North and South Carolina. Journal of economic Perspectives, 10(4), 31-50.
⁹ Syverson, C. (2011). What determines productivity?.  Journal of Economic literature, 49(2), 326-365.}