Increased Productivity Offers Solution to Labor Crisis, at a Cost

Gergely Tardos

Productivity is a cyclical phenomenon. It decreases during recession, when GDP falls, and then it stagnates in early recovery, when growth is fragile, and labor is cheap and abundant. However, productivity tends to grow faster in boom times, when GDP growth is strong and companies cannot hold onto workforce, so they have to invest in order to keep up with the rising demand.

Between 2013 and 2016, Hungary’s annual GDP growth averaged 3.3%, but owing to the dynamic expansion of employment, productivity has remained stagnant. In the 2013-2016 period, employment also grew by 3.3% on average (or by around 2.5% if we exclude the effects of Hungarians working abroad and those on public work schemes).

In 2017 and 2018, GDP growth rates reached 4% and 4.6% respectively, while annual employment growth slowed to 1.5%, so productivity growth jumped to approximately 3%.

This rate is likely to remain until 2020, by which time employment growth will likely stop entirely as the remaining labor market reserves are depleted, Gergely Tardos, chief economist of OTP Bank tells the Budapest Business Journal.

This has two main factors. The first is rising demand, especially domestic, which has brought back economic confidence and pushed capacity utilization higher in domestic demand-driven industries. The second is unemployment, which has fallen to all-time lows.  

These factors have increased companies’ willingness to invest as labor becomes more expensive. “Looking ahead, though, alongside public investments, private investment also started to pick up in 2017 and 2018,” Tardos says. “As the workforce is getting scarce, companies need to raise wages, for which they need to increase their efficiency by boosting investments.”

Productivity also depends on the industry, management skills, the technology applied. “Exporting companies have been able to operate profitably, whereas companies meeting domestic demand, for example construction and telecom companies, were more severely and longer impacted by the crisis,” Tardos adds.  

Éva Palócz

Capital Intensive

These latter companies started to grow stronger as domestic demand began to grow. Hungarian SMEs are less capital intensive than larger firms or multinational competitors that are under more pressure to remain competitive, but can also pay more. The productivity of foreign-owned companies can be three times higher than that of domestic controlled companies – almost the highest rate in the EU, the expert notes.

The productivity gap between smaller and larger Hungarian companies is also one of the highest in the EU. These two factors suggest that Hungarian SMEs face serious competitiveness problems. Many have taken advantage of tax evasion for years and had only modest willingness to invest in growth.  

This duality can be sustainable only for a while and many of the government’s anti-shadow-economy measures (online cash registers, electronic road haulage control system, real-time VAT returns, reducing fiscal burden on labor, etc.) have already improved the situation.  

Also, the generation of entrepreneurs who started their business just after the political transition is now retiring. SMEs are facing labor shortage and wage competition that, eventually, could somewhat shrink the gap between them and large/multinational players, Tardos explains.

“Productivity in Hungary is relatively low because there is an enormous gap between high-productivity (mainly multinational) large companies and domestic SMEs; larger than in countries with similar potential or any other country in the region,” explains Éva Palócz, CEO of Kopint-Tárki Zrt. The key to raising average productivity is if this group of firms gets to improve productivity.  

According to Palócz, it is yet to be seen what effect recent changes such as fast-paced wage growth will have on productivity.  

Replacing Workers

“Even if we deduct the effects of economy whitening, wages have increased significantly, at least 8-10% during the last two years, exceeding multiple times the rate of productivity standing at around 1-2%.” All this might lead to companies starting to invest in technology that can replace workers, Palócz says.

Based on this year’s data, it will be possible to tell if the rapid wage growth that started in 2016 has helped improve average productivity or rather has led to a massive education in the number of small companies, Palócz says. Bad as it may sound, if less productive micro and small companies are closing, that does improve the average productivity of Hungarian companies overall.  

Productivity in Hungary is approximately 60% of that of the European Union average, so a few percent improvement in productivity would result in reducing the effects of the chronic labor shortage, she adds.  

However, investment in more productive technologies is a key factor for improving productivity: it is all the more important to develop and educate the workforce, which should be able to handle these advanced tools. New technologies are not only capital intensive but also human resource intensive. As a result, education and retraining is becoming crucial: a self-driving tractor may replace several farmhands, but it also requires someone well trained to operate it.  

The profitability of Hungarian companies is not bad in general (based on latest available data from 2016).

“Thus a large part of companies would be able to finance, at least partly, smaller investments and banks are keen to lend money for sound projects,” Palócz reckons. Interest rates are historically low, so funding such investments is now easier than finding qualified workforce, she adds.

When it comes to digital development and the services sector, the situation is rather diametric.  

“On the one hand, we have excellent startups with digital solutions and apps that are outstanding in worldwide comparison; on the other, many low-productivity enterprises don’t even have a webpage and never use the internet in their business,” Palócz notes.