Bridging the productivity gap

Diagnostics of firm-level productivity data uncover staggering performance differentials in country after country—indicating the vast untapped economic potential of bridging the productivity gap. This applies not just to a comparison of productivity across countries. Even comparing firms operating in the same country and in the same sector, gaps are large.

Our recent work evaluating firm-level productivity differentials in Albania is a good example of this. In the textiles, apparel and leather sector, the average EU firm is 5 times more productive than the average Albanian firm. This means that the Albanian garment firm needs 5 times as many workers to produce the same output as the average EU firm. Comparing Albanian firms with each other, the productivity of a firm at the top 10 percent of the performance distribution is close to 4 times as high as for a firm in the bottom 10 percent of the sector.

This is a common pattern in many emerging economies. Of course, some performance gaps between firms are to be expected. Even within sectors, firms have different business models, can charge different prices and use different technologies. At any one time, some firms will be buoyed by positive news and some firms will face negative shocks.

Nonetheless, these performance gaps are also suggestive of untapped economic potential. Why are laggard firms not implementing the business practices, investing in the machinery and adopting the technologies of their more successful peers? If unproductive firms do not adapt, why are the better performing firms not taking over market share and driving the laggards out of business?

Figure 1: Albanian productivity gaps are large, both relative to the EU and across Albanian firms

^{Labor productivity of firms in Albania, as percentage of the European Union average.}

To overcome these productivity gaps, many barriers need to be tackled. Some are internal to the firm. For instance, many firms do not realize the possibilities they have to improve their performance. A survey on management practices conducted on 8,000 companies in 20 countries showed that 79 percent of firms claimed to have above-average management practices. Similarly, changing a business is hard. Even if the CEO decides to adopt a new technology or change management style, she needs to build support for the change within the organization. In the end, firms are made up of people—complacency, over-confidence, and fear of change can lead to inaction.

Second, the business environment needs to enable entrepreneurs. For instance, firms need access to capital and skilled labor. Infrastructure needs to connect firms with markets. Red tape needs to be cut. Businesses need reliable enforcement of the rule of law. In Albania, the 2019 enterprise survey finds that 43 percent of firms identify corruption and 40 percent identify the court system as major constraints for their business. Overcoming these challenges and creating a benign business environment is key to enabling entrepreneurs and encouraging business upgrades.

Finally, market competition is needed to drive change. For the adoption of some innovations, new entry by a firm unencumbered by the old ways of doing business is key. Sometimes, the threat of competition can shake up an incumbent firm to reorganize its business. In countries with a large informal sector, firms operating outside the regulatory system can create unfair competition and hold back the growth of formal businesses—a major constraint identified by 37 percent of firms in the 2019 enterprise survey for Albania.

This holds lessons for both the private sector and governments. Businesses need to actively nurture a growth mentality. Outside business development services can be brought in to inject the firm with new know-how and to help overcome internal firm politics. Nick Bloom and co-authors, for instance, find that Indian textile plants working intensively with management consultants increased their productivity by 17 percent within a year and these effects lasted, even after 9 years. Recent studies in Mexico and Colombia have experimented with alternative consultancy services and found that even low-cost support can have a positive impact if designed well.

Governments can help bridge knowledge gaps and nudge firms towards improving their business management, including through training programs and information campaigns. Interventions across sectors are needed to strengthen the business environment, including in financial markets, education, infrastructure, and governance. The principle of open and fair market competition needs to be protected at all times, enshrined in the legal framework and reinforced through practice.

Ultimately, the presence of large performance differentials between firms within the same country also sends a message of hope—small everyday innovations can be a good start to improving business productivity. To increase productivity, it is not always necessary to reach for the next big breakthrough innovation at the worldwide technology frontier. It is not even always necessary to adopt the far-away technologies used by rival companies in more advanced markets. Sometimes, increasing productivity simply means learning from the more productive business next door. Both the private sector and government can and need to do their part to bridge the productivity gap.