Productivity or Employment: Is It a Choice?
Traditionally, shocks to total factor productivity (TFP) are considered exogenous and the response of employment is determined by their effect on aggregate demand. We approach the relationship between TFP and labour input differently, raising the possibility that in response to labour supply shocks firms adjust production efficiency. TFP would, thus, be endogenous to firms’ production decisions. We present cross-country evidence of a strong negative correlation between growth in TFP and labour inputs over the medium to long run. This result is robust to changing datasets, sample periods, and industry composition. To address the question of causality, we use instruments to capture changes in hours worked that are independent of TFP movements and find that TFP growth falls (increases) following a pickup (decline) in hours growth. These results have important policy implications.
Volume (Year): 25 (2013)
Issue (Month): (Spring)
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