Micro Level Dynamics of Productivity Growth: an Empirical Analysis of the Great Leap in Finnish Manufacturing Productivity in 1975-2000

Abstract

This study analyses the dynamics of productivity growth at the micro level in Finnish manufacturing industries. It is shown that productivity-enhancing restructuring (so-called “creative destruction”) has played a crucial role especially since the mid-1980s. Empirical evidence is provided that R&D efforts and exposure to global competition through imports and exports have affected positively with a few years’ lag.

The results for R&D are in accordance with the views that innovations and technological progress entail experimentation, selection and reallocation of resources at the micro level that are important for economic development. An increase in productivity divergence seems to precede increases in creative destruction, which also fits the picture. However, at the same time creative destruction also compresses productivity dispersion by cleansing low productivity units. No empirical evidence is found that wage dispersion between plants has a positive effect. The positive effect of international trade, in turn, points to the importance of product market competition which is emphasised in the recent theoretical literature. Finally, the main part of productivity-enhancing restructuring can be attributed to newly established plants, which indicates the importance of entrants to creative destruction.

Various aspects of identifying and measuring the components of aggregate productivity growth by means of productivity decomposition methods are discussed in detail. It is demonstrated that there is a great variation between the results obtained by different methods. Some new variants of the methods are proposed. These tools have two main advantages. Firstly, they yield components that are useful when evaluating the usefulness of the representative firm model. Secondly, the results are not very sensitive to the usual measurement problems inherent in micro data.

The usual caveat of ignoring labour quality in productivity decompositions is tackled by using linked employer-employee data. These data allow the measurement of labour input in so-called “efficiency units”. No empirical evidence is found that the productivity steps taken have been just factitious increases gained by the displacement of the lower educated and less experienced workers through micro level restructuring.

Productivity-enhancing restructuring also has implications for the dynamics of factor income shares. The payroll shares of plants have been reallocated from plants having a low capital-to-value-added ratio to those having a high capital-to-value-added ratio. The reshuffling of the payroll shares of plants has contributed positively to an increase in the capital’s factor income share at the aggregate level.

Because micro level restructuring is of vital importance for economic growth, the factors that affect this process deserve careful consideration when the policy actions or reforms of institutions are designed. Innovations and R&D are important, but alone they may not be enough. Product market competition is likely to have a decisive role. In addition, well-functioning financial and labour markets and a high skill level in the workforce are also key factors facilitating the renewal of the economy at the micro level.