The problem with productivity


Many measures in economics require close scrutiny to assess their efficacy. Of course, no measure is a problem in itself. But they are usually attached to popular metaphors that can be very much a problem. Productivity is one such measure/metaphor. Whether it is labour productivity or multi-factor productivity, productivity is an industrial-era measure that tracks output relative to input. In the industrial era, it was reasonably effective at showing how hard and how smart people worked. The metaphor, accordingly, is that productivity = working hard, putting your head down, getting on with the job, setting your nose to the grindstone, wanting a good day’s work for a good day’s pay and just being a decent member of society (having a beer after work before going home to the family). Images of salt of the earth types shifting heavy machinery spring to mind. Conversely, falling productivity immediately connotes laziness, bums living off welfare, workers pretending to be sick when they are really betting on the horses, unions trying to get undeserved free kicks and ruining things for everyone.

Such nonsense suits the political environment, but in the real world, productivity is so flimsy an indicator it should be approached with extreme scepticism. Productivity in America, for instance, “improved” sharply after the GFC, when the American economy was ailing. It has “worsened” in Australia even as Australia’s economy has proven the most resilient in the developed world. True, it is not just about the present state of the economy. The claim is that changes in productivity indicate future problems, that Australia is making a difficulty for itself because of bad industrial relations, a lack of “reform”, lazy workers. The metaphor rolls on. It is a distorted picture. There may be problems, and they may be of the type described (since when haven’t there been problems in the work force?). But for the most part they are of a different kind. A paper by the Reserve Bank has indicated that Australia’s poor productivity figures are principally a capital accumulation problem:

“The productivity figures are being skewed by a sharp rise in investment and capital accumulation last decade in the capital-intensive mining and utilities industries. 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. 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.[3] 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.
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.”


The reality, in other words, does not fit the metaphor of lazy workers, unions screwing everything up, etc. Heavy capital accumulation in mining because of the boom and what is probably over investment in infrastructure, especially in energy, has resulted in lower output per dollar allocated.

What is needed, with such a flimsy indicator as productivity, is a number of other analyses to be run parallel with its use. For one thing, about two thirds of productivity gains come from capital investment, not improved work patterns. This is to some extent a false dichotomy (workers have to use the new technology well), but it does indicate an obvious fact. There are limits to how much harder workers can work. But there are no limits to how much technology can be improved or how much smarter workers can work. So what is needed is not so much a quantitative measure of input-output but a qualitative measure of brains-output. What Peter Drucker called the knowledge economy. Of course, qualitative measures are not the strong suit of economists, but that is what is needed. It is especially important in areas of the economy that are not simple consumer products, such as health and education. Input-output analyses work well enough when you are talking cars or shoes or plasma TVs. Same in mining. But in many of the more complex service sectors, that is far too simplistic.And what the Reserve Bank is showing is that in Australia there are big questions about the validity of the capital investment.

Second, the really big improvements, productivity or otherwise, come from advances in systems. This is a perennial problem in the atomistic approach to economic activity. The assumption that the only way forward is each firm improving their activity individually because competition is fierce. That is only part of the story. If the individual firms persist with the same practices, then you often do not get system wide advances. And in the utilities sector, in particular, what is needed is system wide advances, a new way of configuring things that is more distributive and adaptable.


I note that Ceramic Fuel Cells, an Australian firm that produced energy from gas, with low emissions and potentially very cheaply, has just decamped for overseas because it got no help from the Australian government or the utilities. The Labor government refused to allow a rebate for the cells because it used fossil fuels, although emissions were extremely low — a classic piece of fundamentalist stupidity, Penny Wong being the minister at the time. If the rebate for feeding electricity back into the grid had been at the going rate to customers, the units would pay for themselves in about four years and then give an energy price indefinitely at about half the current rate. And because the units could be localised — they are about the size of washing machine — a system could be developed that could be more adaptive to peak demand than the current centralised, inefficient system. So why no support from the Federal government and utilities (who stood to gain the most)? There may be a smell of corruption, but what we can say for sure is that there is no interest from existing players to change because they might lose their revenues. They want to sell as much energy as they can, not deliver the best result for consumers. And the government, despite having one answer to the problem staring it in the face (whcih was invented by the CSIRO) showed zero vision. And now what do we get from the energy white paper? Admonitions for privatisation and more fierce atomistic competition. We are a long way from the visionary leadership that was shown at the start of the Industrial Revolution in areas like roads, rail, dams and power, when brilliant engineers imagined a new world and created it.

Productivity completely falls down as a measure in the finance sector. The reason is that you cannot measure money with itself. How is productivity measured? Output per dollar of capital invested. What is the output of the finance sector? Capital. Capital cannot measure capital. Put another way, if “productivity” in the finance sector rises, that means more money is being produced. That is very different to producing more cars. In fact, the productivity of the sector in the run up to the GFC was fantastic — and that was why we had a GFC. The sector “produced” massive amounts of leverage very efficiently and as a consequence the excessive debt nearly brought the world’s financial system to its knees. Financial productivity, in other words, was a curse.

Once again, the finance sector should be seen as a special case, not like the rest of the economy.


Like many economic indicators, productivity is an old fashioned measure for an old fashioned world view. What is needed for the future is just as much “receptivity” as productivity; an understanding of what value is to the user, not just what value is to the producer. I doubt that this will emerge any time soon.