Thursday 15 October 2015

O-Ring models and NZ productivity

The long low-productivity tail of firms isn't just a New Zealand problem. Here's Alex Tabarrok on a new OECD report. The key image is this one: the gap between frontier firms and everyone else is becoming huge.


Tyler Cowen wonders whether this might be due to O-Ring production models. Where the highest valued stuff requires having zero screw-ups at any point down the line, the returns to having no screw-ups start increasing hugely.

As Alex points out in this helpful explainer, the top firms pay the most across all tasks, even the low value tasks, because they can't afford to have anything go wrong.

I suspect that this is, in part, behind New Zealand's fairly flat inequality stats. We don't really have many of the frontier firms, so we don't get frontier firm salaries, so we don't have the run-up in top salaries - and it's not really to the country's longer run benefit either.

Here's Cowen:
Yesterday Alex outlined the facts, which I take to be not in dispute. Firms at the frontier have seen significant productivity gains, the others not so much. Alex calls this a “lack of innovation diffusion” and considers whether IP law might be one cause.

My framing is somewhat different. The result reminds me of the international trade literature on why so few firms export. The notions of increasing returns to scale, and fixed costs to trade abroad, provide the beginnings of an answer. In such a setting, let’s say the world has become more globalized, more IRS, and more based on learning curves, much of those trends being attributable to information technology. In that case we would expect a growing bifurcation of firm productivity outcomes, just as we find a strong bifurcation of export outcomes, with a relatively small percentage of firms doing most of the international trade, or innovating, as the case may be. The “only a small percentage of firms export” and the “only a small percentage of firms are on the productivity frontier” may sometimes even be the same way of describing the same basic fact.

The on the ground reality I observe is that the large, famous, exporting firms put together fantastic O-Ring teams of talent in a way the smaller, medium-size enterprises do not. That is the relevant diffusion barrier, but of course there may be limits on that diffusion as well. Eliminating barriers across firms is a good idea but not enough either.
It's worth thinking through the implications for New Zealand.

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