Treasury Secretary Martin Parkinson gave an epochal speech at the Sydney Institute last night. Highlights include arguments to raise the GST, the need to boost productivity to unprecedented levels if we’re not to get poorer and argued for radical steps to stabilise the budget. It was brilliant.
Below I’ve excerpted the section on productivity and income which clearly maps out a nation with declining standards of living without change but I suggest you read it in full.
My only issue is with the psychobabblian insistence on couching this generational national threat as an opportunity. The nation needs a “banana republic” moment not more soothing rhetoric.
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Australia’s Productivity Performance in Context
Like any economic indicator, productivity is a concept that can tend to be misused and manipulated. So allow me to take a few moments to be clear about Australia’s recent productivity performance.
Australia’s multifactor productivity growth – the best available measure of how efficiently we are using inputs – has seen a marked deterioration since around the turn of the century. Indeed, it is now negative.
To some degree, this has been driven by unprecedented investment activity in mining and, to a lesser extent, developments in the utilities industries.
That is, this investment has not yet been fully reflected in increased output, particularly in the mining sector, partly because of lags between when investments are made and when capital becomes fully operational.
In mining, it is reasonable to expect further output growth and strong productivity growth as the investment pipeline reaches completion and utilisation of the increased capital stock rises.
But even removing the effect of the mining and utilities industries reveals that the slowdown in multifactor productivity has been broad-based across industries, suggesting that deeper, economy-wide factors are at play.
Australia is not alone among advanced economies in experiencing slower productivity growth over the past decade. This suggests that the expansion of the global productivity frontier may have been more modest during the 2000s than in earlier decades. If so, this raises questions about the pace of growth in living standards in the decades to come.
Even so, it is hard to argue that Australia’s productivity growth performance has not been weak over the past decade, both by advanced economy standards and our own past performance. If true, this has implications for future growth in living standards.
Notwithstanding this slowdown in Australia’s productivity growth performance, growth in Australia’s national income has remained strong, due largely to rises in the prices of iron ore and coal, which pushed Australia’s terms of trade to the highest sustained level in at least the past 150 years.
The terms of trade peaked in the September quarter of 2011 and have declined since then as the prices for Australia’s key commodity exports eased in line with growing world supply.
The Treasury’s modelling suggests a long-run terms of trade settling around the level observed in 2005-06 by around 2019-20.
While it is unlikely that the transition to a lower terms of trade will be as smooth as depicted in the chart, we can be confident that rising commodity prices will not be a source of significant national income growth over the next decade!
Rather, our modelling (and that of the mining companies themselves) suggests that falling terms of trade will be a significant drag on Australia’s national income growth over the medium term.
Another contributor to Australia’s previous strong growth was, of course, the demographic dividend delivered by the baby boomers.
Between 1970 and 2010, the proportion of Australia’s population between 15 and 64 increased from 62.8 per cent to 67.4 per cent, driven by the post-war baby boom, followed by a dramatic fall in the birth rate in the 1960s and 70s.
This increase in the working age population helped underpin GDP growth, particularly in the 1980s, when labour productivity growth was relatively poor.
Over the next few years, this demographic dividend, which has been fading for some time, will actually reverse. The proportion of the population aged 65 and over is expected to increase to nearly 20 per cent in 2030, from 13.5 per cent in 2010.
As the population ages, the total participation rate will fall – despite the increase in the participation rate among older Australians.
This expected decline has already begun and will become more pronounced by the end of the decade.
Thinking about the population projections in a slightly different way, based on 2010 Intergenerational Report projections, by 2050, there will be only 2.7 people of working age to support each Australian aged 65 years or over, compared with 5 working age people per aged person in 2010, and 7.5 in 1970.
This population ageing will slow economic growth in coming decades and, in turn, will reduce growth in our future revenue base.
Population ageing will also, of course, create additional demands on government spending, particularly in health, aged care and pensions.
In short, our three phenomena – weak productivity growth, a falling terms of trade, and an ageing population – do not bode well for growth in Australian incomes and living standards in the period ahead.
This chart shows that productivity, the terms of trade and labour utilisation – or hours worked per head of population – have combined to drive income growth in the past.
As you can see, productivity is the key long-run driver of income growth and its role will be crucial in the coming decade. The terms of trade and labour utilisation have made significant contributions in the past but, as I have just outlined, they are expected to detract from national income growth over the period ahead.
Looking ahead, if we assume labour productivity grows at its long-term average, then per capita incomes would grow on average over the decade ahead by around ¾ of a per cent per year, or about a third of the rates to which Australians have become accustomed.
To achieve average income growth in line with its long-term average, we would need sustained labour productivity growth of around 3 per cent. This is significantly more than in the past and around double what has been achieved since the turn of the century.
A stark conclusion of this chart is that, with labour utilisation and the terms of trade falling, productivity growth is the only remaining driver of income growth in the period ahead.
The impact of productivity growth rates on our future livings standards can be seen clearly in the following chart.
If labour productivity were to grow at its long-term average, per capita incomes would grow on average over the decade ahead by only 0.7 per cent per year, leading to real income per capita of around $69,000 by 2024.
These rates would be much less than the 2.3 per cent growth Australians are used to, which would otherwise yield a real income per capita of around $82,000 by 2024. So there’s a gap of around $13,000 per person between what Australians might hope for and expect, and what might come to pass, on the basis of a reasonably benign scenario.
By the end of the decade, we will face growth in income per capita of around the rates experienced over the decade ending with the recession of the early 1980s.
Notwithstanding the differences in circumstances, Australians may look to government of all levels for support, placing further strain on budgets and fiscal sustainability.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
