Study: More efficient allocation of labour and capital would increase productivity and economic wellbeing

The misallocation of labour and capital in the Finnish business sector has increased in the 2000s, which has significantly retarded productivity growth. The concentration of labour to companies with lower productivity is a key factor in retarding growth. A more efficient allocation of labour could be influenced, for example, by dismantling incentive traps and increasing labour mobility and wage competition, states a recent study by Aalto University and ETLA Economic Research.

The allocation of labour and capital is currently in a state of change in the Finnish business sector, influenced not only by the structural change in the domestic economy, but also by various megatrends, such as digitalisation, climate change and population ageing. However, information on the efficiency of resource allocation and productivity impacts in Finland is scarce.

A study funded by the Finnish Government’s analysis, assessment and research activities examined the effectiveness of the allocation of labour and capital in Finland, that is, the impact of the allocation on productivity growth, and the policy measures that could be taken to improve it.

According to the study, resource misallocation has increased in Finland’s business sector in the 2000s, which is the principal factor retarding productivity growth. The increase in misallocation is primarily due to insufficient labour transfer from companies with lower productivity to companies with higher productivity.

“In the Finnish business sector, the allocation of labour inputs is less effective today than the allocation of capital. The allocation of labour seems particularly ineffective for start-ups and small enterprises,” says Professor Timo Kuosmanen, Ph.D. (Econ.), principal investigator of the study at Aalto University.

Labour market policy instruments and the assessment of aid to start-ups and small enterprises could help improve the situation

More efficient allocation of labour and capital to companies with above-average productivity growth would significantly increase productivity and economic wellbeing. According to the study, productivity has a growth potential of 40–250% in industry and 10–70% in services. In the current situation, resources are dispersed among too many companies with low productivity levels. Many start-ups are, on average, more productive than companies exiting the market, but start-ups are unable to take advantage of the competitive advantage of their high productivity levels to expand their operations.

In addition to labour market policy instruments, the allocation of resources could be improved by a critical assessment of aid and incentives directed to start-ups and small enterprises. The examination of barriers to entry should also be extended to companies considering switching industries.

“Concrete ways to improve labour allocation include increasing labour mobility and wage competition, dismantling incentive traps and upgrading skills,” says Terhi Maczulskij, Ph.D. (Econ.), Chief Research Scientist and principal investigator of the study at ETLA.

The study was carried out by Aalto University and ETLA Economic Research. The publication is part of the implementation of the Government Plan for Analysis, Assessment and Research for 2021.

Further information: Professor Timo Kuosmanen, Aalto University, tel. +358 40 353 8393, timo.kuosmanen(at)aalto.fi, and Terhi Maczulskij, Chief Research Scientist, ETLA, tel. +358 50 323 0180, terhi.maczulskij(at)etla.fi

The Government’s joint analysis, assessment and research activities (VN TEAS) produce data used to support decision-making, everyday operations and knowledge-based management. They are guided by the Government’s annual plan for analysis, assessment and research. The content of the reports published in the publication series of the Government’s analysis, assessment and research activities is the responsibility of the producers of the data in question and does not necessarily represent the view of the Government. For more information, visit https://tietokayttoon.fi/en.