As we have written in previous reports, what fundamentally drives economic growth over the long term is the change in a country’s workforce and its change in productivity. This is the simple equation:

Real Potential GDP Growth = Workforce + Productivity

We have discussed the first part of the equation numerous times. We would now like to briefly discuss the second portion of the equation. For a nation such as Bermuda which suffers from a low if not stagnant working population, capital allocated to productivity-enhancing endeavours and the revamping of business processes will be critical components to maintain the island’s standard of living and growth.

Productivity, however, has been in decline since the great financial crisis and is truly a global phenomenon. There are potentially several reasons for this dropping productivity, but we will highlight three possible explanations for Bermuda:

1, Excessive debt. The theory here is the more capital and money expended on servicing debt, the less is available for productivity-enhancing investment.

2, Ageing and Ailing Workforce. It would be incorrect to suggest older workers are less productive, but it is hard to suggest that older workers whom are sick are more productive than the young and healthy. As Bermuda’s demographic shift continues and we become an older society susceptible to increasing age-related health issues, we are likely to see continued degradation in our productive labour capital.

3, Business mix. Over time, Bermuda has had the benefit of transitioning to more productive industries; initially, an agrarian society, to one of tourism and then an economy dominated by international business. Each phase of the transition has brought about a new, more scalable industry with far greater wealth per worker. As a result, through the ages Bermuda has enjoyed a natural transition upward in productivity.

This transition has stalled over the past couple of decades as the growth in international business peaked in 2002. There was a wave of new reinsurance companies formed on the island following the 9/11 attacks. Unfortunately, the financial crisis helped cause a significant consolidation of the industry which has continued due to changing insurance industry dynamics.

Table 1 details Bermuda’s productivity.

With a rate of productivity of around 1 per cent and a working population declining at a similar negative rate, the prospects for real GDP growth are meagre at best.

Fixing the productivity problem is important. Ramping up the level of productivity can help Bermuda in the following three ways:

1, Lower the cost of doing business. Ramping productivity allows for a higher level of output for the same level of input. Thus, scale can be gained which in turn may help eliminate expenses and produce goods and services at a lower cost. There is a paradox to this in Bermuda, which we will discuss below.

2, Increased wages for workers. Productivity growth pays dividends for workers. Higher productivity benefits workers through higher wages. As a worker can produce more, companies and employers are better able to pay them more.

3, Increased foreign investment. High productivity environments attract foreign investment, and this ultimately means more jobs for Bermudians. If the Bermudian tourism product, as an example, exhibits high productivity (and by association higher profitability), more foreign investment is likely to follow. The opposite, of course, is a major detractor.

4, Ultimately faster GDP growth. As noted above, increasing productivity ultimately boosts overall growth. GDP growth is a necessary factor needed for Bermuda to tackle and address its escalating entitlement deficit, fiscal deficit and healthcare cost inflation. Growth in a low-level debt environment is not as important but given our situation it is a necessary element.

All these benefits of higher productivity ultimately lead to a higher standard of living for all in Bermuda. When costs are lowered, and wages advanced, much more can be accrued from an honest day’s work. The struggles we hear can be alleviated greatly over time by a focus on productivity.

Bermuda Productivity Paradox

The need and desire for higher levels of productivity comes with an unfortunate paradox on our island. Much of the productivity gains seen locally since the great financial crisis have come at the expense of jobs. We have seen waves of outsourcing and downsizing as companies have attempted to resize to the new environment and lower level of aggregate demand. Less workers have been required to do more in all sorts of industries on the island. As a result, it has become evident that to reduce the costs on the island there may actually need to be an associated reduction in labour costs. We will go through three local examples and the quandary they impose on Bermuda:

1, Lowering power prices. The current labour dispute at Belco is a perfect example of the productivity paradox facing Bermuda. Ascendant Group (Belco’s parent company) has announced a plan to make the company more efficient. Everybody agrees that the cost of power in Bermuda is too high and is a major factor impacting Bermuda’s competitiveness compared to other countries. While part of the solution is new and more productive generation, management has argued that the labour component impacting power prices in Bermuda is significantly higher than other comparable jurisdictions.

Management has developed a plan to tackle this issue to become more productive and reduce the cost of power for the entire island. Four senior executives at Ascendant Group have either resigned or have been made redundant in what has been reported to be a dispute with a management job reduction plan. This followed Ascendant’s decision to outsource three marketing jobs in September.

The reaction to these executives losing their jobs was for the Electrical Services Trade Union to down their tools. From a recent presentation by Ascendant we were shown a breakdown in power prices for an average consumer at $0.39/kWh for 2018. Of this $0.11/kWh was attributed to labour in Belco and Ascendant shared services. In Cayman, as a comparison, their $0.32/kWh comparable average contains only about $0.01/kWh of labour.

If we are truly set on lowering the overall cost of power in Bermuda, this figure at least needs to be considered. The total reduction, of course, does not need to be borne solely by labour — five cents of this is estimated to be government fuel tax and duty, which we would suggest should be dramatically lowered — but it is a substantial sum. This approximate $30 million in fuel taxes/duties has doubled since 2015 and Cayman taxes/duties has been cut in half since 2015. The paradox is clear here; if the entire island wants lower power prices some difficult decisions will need to be made that will not be favourable to select groups.

2, Lowering healthcare costs. There is a plan now being circulated that suggests a pooling of all individuals into one giant plan or two plans for all of Bermuda healthcare. The thinking behind this is that we will have a more inclusive healthcare plan for all Bermudians and one which is cheaper given the scale involved. Noble intentions indeed, but the devil’s in the details. The unintended consequence, however, is the likely downsizing of employment at private healthcare providers. Again, to reduce an expense for all, a select group of jobs may need to be reduced.

3, Lowering government taxes. This one may create the largest productivity paradox. The Civil Service cost consists roughly of about 75 per cent in employment costs. The increasing level of government and its notoriously inefficient bureaucracy, with rather low levels of productivity, is placing an enormous burden on the private sector.

To fund the government, its entitlement programmes and debt escalation, higher and higher taxes and fees are being imposed on the private sector. Increased costs are limiting local companies (and likely exempt ones) from adding jobs. Lowering government expenditures and making the government productive will almost assuredly result in lower levels of government employees. It is virtually impossible to lower the cost of government without considering this. A lower level of government could lead to reduced taxes and fees and the increased ability of the private sector to invest and hire to enhance overall productivity. The recent announcement by the Government to reform the quangos is a logical example of improving productivity.

The desire for a highly productive island and the benefits it entails is assuredly an important consideration for Bermuda. It is important, however, to consider the true human cost. While desirable, and in fact necessary in the long run, the focus on productivity and its benefits is almost assuredly to come at the cost of some levels of employment in Bermuda. Therefore, it is essential and critical to remain open to new company formation, immigration and business development to create opportunities for those shifted among industries to participate in a more efficient country.

Creating private sector employment options to government workers would benefit the economy over the long run. Without creative destruction and shifts, however, it is not likely that we will see any form of meaningful growth in Bermuda over the medium to long term.

•Nathan Kowalski CPA, CA, CFA, CIM is the chief financial officer of Anchor Investment Management Ltd. and can be contacted at nkowalski@anchor.bm. The sole responsibility for the content of this article, lies with the author. It does not necessarily reflect the opinion, policy or position of Anchor Investment Management Ltd. The content of this article is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy or for any other purpose. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by the author to be reliable. They are not necessarily all-inclusive, are not guaranteed as to accuracy and are current only at the time written. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. Readers should consult their professional financial advisers prior to any investment decision. The author may own securities discussed in this article. Index performance is shown for illustrative purposes only. You cannot invest directly in an index. The author respects the intellectual property rights of others. Trade mark or copyright claims should be directed to the author by e-mail