The productivity perfect storm

In today’s RBA Bulletin, Patrick D’Arcy and Linus Gustafsson produced a fascinating study of what has caused Australia’s post-millennium productivity slump. Called Productivity Performance and Real Incomes, this thing is a piece of work.

It begins with a chart of the slump:

Then blames a fair slice of it on the mining and utilities sectors:

In the case of the mining industry, the fall in  productivity is partly a natural consequence of  the rapid run-up in commodity prices, which has increased the profitability of more marginal deposits. Higher commodity prices justify more difficult and costly extraction of previously undeveloped resources, which becomes necessary over time as developed deposits are depleted. The very rapid pick-up in commodity prices has also justified an unprecedented increase in capital investment in the industry. This growth in measured capital inputs has detracted from measured productivity owing to the lag (of some years) between the initial investments,  the completion of projects and the utilisation of  all the new capacity. In effect, the productivity  developments in the mining industry are best  characterised as a movement up the industry’s supply curve, rather than an exogenous shift in the supply curve related to some fundamental change in underlying productivity.

And for utilities:

The fall in the level of productivity in the utilities industry is also related to large investments, which have been necessary to deal with some of the fundamental structural challenges facing the industry, but these investments have not necessarily resulted in higher quantities of measured output. Part of the surge in investment over recent years reflects a significant catch-up that has required rapid
growth in utilities’ workforces after a period in the 1990s when investment and employment in the industry were falling.

There has also been additional investment to  improve the reliability of supply in the electricity and  water industries, which has only made a marginal  contribution in terms of additional measured  output. One example is recent investment in  desalination plants that, with the return to high  rainfall in recent years, are not currently being  utilised fully, but will provide a source of fresh water in the event of future droughts.

But it does not stop there. The study goes on to note that wider industry productivity growth rates also fell:

Multifactor productivity outcomes in the 2000s were  clearly weaker than the period of strong growth in  the 1990s. However, the difference between trend  growth in the 2000s and the long-run average prior  to the 1990s is less marked. For the market sector  excluding mining and utilities, the average growth  in multifactor productivity of 0.4  per cent in the  2000s is only 0.2 percentage points lower than the  average for the market sector in the period 1973/74  to 1993/94. This suggests that it is the 1990s that was  the period of exceptional growth.

The study then goes on to examine why the 1990s period was exceptional:

That productivity growth has slowed across a large  number of developed economies in the 2000s  provides some indication that there may have been  a slowing in the pace at which the technological  frontier is expanding. Data on productivity  growth for members of the Organisation for  Economic Co-operation and Development  (OECD) indicate a fairly universal slowing in  productivity growth in the 2000s compared with  the 1990s, with 19 of 25 countries experiencing  a slowdown in productivity growth.

It is difficult to be conclusive about what might have driven this common international experience, but it suggests that part of the slowdown may be related to common global factors, such as the pace of technological innovation and adoption.

This obviously contrasts with the popular version of events widely accepted in Australian economic circles that:

…the  acceleration and subsequent slowing in productivity  growth over the past two decades relates to the  gradual waning of the impetus to productivity  growth initiated by the economic policy reforms of  the 1980s and 1990s (Dolman 2009; Eslake 2011).  These reforms, which included tariff reductions,  privatisation, liberalisation of financial markets,  decentralisation of the labour market and,  somewhat later, national competition policies and  tax reform, are widely viewed as having contributed  to a marked improvement in economic efficiency.

The overall effect of all these reforms was to increase  competitive pressures on firms in product markets  such that improvements in productivity became  an imperative for economic survival, while at the  same time increased flexibility in capital and labour  markets ensured that economic resources were  allocated more efficiently among competing firms.  It is difficult to be definitive about the magnitude  of the impact of regulatory reforms, as in many  cases, for example with tariff cuts, the changes were  introduced gradually over an extended period  of time, with the impact on productivity occurring only with a lag.

While some analysts have argued that these  reforms should have permanently lifted the growth  rate of productivity relative to the unobserved  counterfactual, the experience of the past two  decades suggests that the effect on productivity growth may have been temporary. Productivity  growth appears to have been higher during a  ‘catch-up’ period when reorganisation in response  to the reforms drove improvements in economic  efficiency allowing the economy to move closer  to the production frontier.

To this we could obviously add the clear consolidation that we have seen across all industry sectors since 1990s, taking away much of the competitive impulse to find efficiencies.

This study is really worth reading and is quite enlightening but it also has two shortcomings. Take a look at this analysis from the New Zealand Treasury early last year:

New Zealand’s growth in the period leading up to the GFC (2002 to 2008) was associated with rapid credit expansion, fast growth in consumption, high external borrowing, low private saving, a house and farm price boom, high government tax revenues and spending, and static tradable sector growth. Growth on this basis was unsustainable and had several negative consequences including rapid growth of private-sector debt and a high NFL-to-GDP ratio [see below chart].

There are important connections among these factors and the disappointing growth outcomes…

Easy access to credit (particularly for property financing) was associated with rapidly escalating farm and house prices.

The property boom in turn led households to feel wealthier and increase their consumption. Strong growth in nominal GDP buoyed tax revenues and encouraged often ill-judged growth in government spending.

High growth rates of private and public consumption created inflationary pressure that led the Reserve Bank to raise the official cash rate. This, in turn, pushed up the exchange rate.

This standard monetary policy response led to unbalanced growth: reduced exports and increased imports, with a rise in the proportion of domestic resources going to non-tradable production and a reduction in the proportion flowing to tradable production.

It is likely that the reduction in export competitiveness has, in turn, slowed productivity growth. There is evidence that a lower exchange rate creates opportunities for high-productivity firms to grow, achieve scale through exporting, and contribute a range of spill-over benefits to other firms. In contrast, what happened is that non-tradable industries such as construction and property and business services expanded rapidly and attracted labour and other resources at the cost of their availability to export industries such as agriculture and food processing…

Bingo. The same process transpired in Australia but was coupled with a commodities boom that was also drove up the exchange rate. I see no reason why the same effect of displacing tradeables wouldn’t have transpired in Australia, but on steroids.

Put all of these factors together – increased concentration with lowered competition, a fading tech revolution, heavy but not efficiency boosting infrastructure renewal, falling productivity related reform, less efficient mines, consumption displacing tradeables lowering competition further – and you have pressure upon both labour and capital efficiency.

Is it any wonder we got no damn productivity?


David Llewellyn-Smith
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  1. Thanks for the post. Really interesting.

    The last paragraph of the RBA report is a bit of a worry as well.

    So the NBN is not going to save us then?

      • Well … it can’t possibly be worse than the impact of the mining boom on productivity.

        I thought this interesting…

        There is evidence that a lower exchange rate creates opportunities for high-productivity firms to grow, achieve scale through exporting, and contribute a range of spill-over benefits to other firms.

        Who needs productivity? Sell them dirt.

      • Jumping jack flash

        couldn’t agree more 3d1k. It is a service, therefore it will be a leech on real productivity.

        Unless it is priced competitively, and there is next to no chance of that happening if Telstra are involved in any way. Telstra’s overcharging of businesses for their “services” is legendary.

        And I personally can’t see many productivity gains from people using it to access pron more quickly, and download pirated music and movies just that little bit faster.

        • Well certainly jjf, if that is all some people can see in the NBN, they will certainly not get any productivity improvement in their particular businesses. Mind you, if competing businesses can see a way to get an edge with the faster and more reliable service, that might be the last thing that the slower businesses see on the way to the bankruptcy court. There are always early and late adopters of any new technology.

  2. Alex Heyworth

    Productivity in the utilities sector should improve dramatically as prices rise.

  3. You see legislate and bureaucratic overhead being non contributory to productivity not increasing ? This bureaucratic “load” seems ubiquitous across the OECD.

    or am I off the mark in terms of what the productivity metric is ?

  4. People analysing productivity need to realise that urban planning and inflated urban land costs have a negative effect. The McKinsey Institute’s 1998 paper, “Driving Productivity and Growth in the UK Economy” claimed that this was the main reason that the UK’s productivity still lagged its main trading partners by 20% to 40% even after all the Thatcher era liberalisations.

    Alan W. Evans (Head of the Spatial Economics Research Centre at the University of Reading) expands on the McKinsey insights in his 2004 book, “Economics and Land Use Planning”. The Spatial Economics Research Centre at the London School of Economics has been doing continued ongoing research into this point and it is well worth looking at their recent Summary paper: “What We Know (and Don’t Know) About the Links between Planning and Economic Performance”, by Max Nathan and Henry Overman.

    There is almost certain to be a connection between heavy-handed urban planning and inflated urban land prices, and disappointing productivity performance in Australia and many other countries right now.

    I know urban planning can’t impact mining sector productivity by much, but the experts are saying why the mining sector has low productivity, it is the urban economy that is baffling them. The British academics referred to above have some damning things to say about the consequences of almost the entire economics profession lacking any training or interest or expertise in the economic distortions caused by urban planning. Because they understand labour markets and taxes and trade and so on, they look for solutions there, like the guy looking for his wallett where the light was good rather than where he actually lost it.

    • I’ll pipe in. By no means having anything like your expertise in this area. The cost of housing in mining areas. Ridiculous. Yet, at least in WA, these location are surrounded by nothing but….land. Millions of square kilometres of it.

      Local and State Governments really need to address the ‘release’, for goodness sake, release? of land in regions where land is everywhere.

      • Land is being released everwhere here – thousands of people with their own school and shopping centre are projected to be living just down the road from me in a few short years (wrecking my peaceful position of being a short drive from town but without the noise. Humph!) – everywhere I drive around here allottments are being released, machines are transforming the land into suburbia – but the price just won’t come down.

        “Here’s where the money is – here and Karratha” I overheard a fluro shirted bloke say at my local the other night. Yep – and a million investors in this country know it. And they are willing and able to bid up the price on the prosect of fat returns and the banks obviously still stand willing to finance them.

        It’s the speculation baby. I know it’s a popular position on this blog that much of the problem of runaway pricing is with supply but as long as someone stands willing to finance it, demand (greed) has no limits and can always expand faster.

        • The Patrician

          RP data June 2012

          “They also note that vacant land sales are some -40% below average levels, however, lot prices have remained relatively stable”

          That statement has to be a FIRE alarm.

          Talk about an inelastic market!

          Those “stable” prices are bolted into the foundations of the “politico housing complex”. You could double supply and they wouldn’t budge. Somethings gotta give.

        • “Land being released” is simply a classic economic “quota” scheme. No-one with 2 economics brain cells to rub together should think that would bring house prices down.

          You are completely wrong about the ability of “greed” to keep up with land supply come what may. The annual Demographia reports reveal that around 200 out of 260 US cities had stable prices right through the catastrophic bubble that affected California and specific local markets around the rest of the USA. The basic reason is a LACK of constraint on urban development, period.

          Some of these stable land price cities grew by staggering population amounts 2000 to 2010; cities with 3 million and 4 million people, added another whole 1 million in 10 years; check out Houston, Dallas, Austin, Atlanta, Raleigh, Charlotte…..

          When there are no restrictions on development, it is simply impossible for an oligopoly or a group-think set to “corner” the land supply; there is always opportunity for someone to sneak in with a sharper price to meet a segment of the market that no-one else is. But the whole process actually remains a genuine virtuous “competition on price”.

      • 3d1k; b—-y good POINT.

        I now remember reading about that somewhere, and I had forgotten. I wish I could find it again; was it analysed by Oliver Hartwich when he was with CIS; or was it Alan Moran; or Bob Day; or Leith Van O?

  5. Lordy Lordy!

    The folks in the developed world are just now figuring out that the neoliberalism that was rolled out in the 1990s, which is nothing more than a repeat of the same old state monopoly finance capitalism of old but with a fancy new name, doesn’t work. Earth to Australia: “It has never worked!”

    From your graph it’s quite obvious that the FIRE sector and the technocrats certainly haven’t suffered in the last 7 years. I wonder why that is.

    Here’s how Joseph Chamberlain summed it up in a speech to a group of bankers in the City of London in 1904:

    [quote]Are you entirely beyond anxiety as to the permancence of your great positon?… Banking is not the creator of our prosperity, but is the creation of it. It is not the cause of our wealth, but it is the consequence of our wealth, and if the industrial energy and development which has been going on for so many years in this country were to be hindered or relaxed, then finance, and all that finance means, will follow trade to the countries which are more successful than ourselves.[end quote]

  6. Aristophrenia

    I’m not exactly sure the point that is being made here.

    The popular Australian memes which claim productivity kicked in due to deregulation, then waned as these wore off stands in contrast to what ?

    Is it being claimed that these did not have a stimulus to productivity ? Or is it simply being claimed that the allocation of wealth and resources towards speculation and consumption drove down productivity after this period and there is no reflection on the causes of the 90’s other than the popular Australian memes ?

  7. One thing that needs to be considered when discussing efficiency is outsourcing.

    Assume a company wants build 1,000 widgets. Now assume its leading business cases result in the below options
    1.) Build a machine and reduce labour = Total unit cost: $1.5 per unit
    2.) Outsource to china = Total unit cost $1.5 per unit

    In this situation I often found management would choose to outsource the product due to a perception of less risk.

    When managers make decisions like this it leads to missed opportunities to improve Australia’s efficiency.