PC: Australia’s productivity stall threatens living standards

By Leith van Onselen

The Productivity Commission (PC) has delivered a damning assessment of Australia’s productivity performance over the past 12 years in a new discussion paper entitled “Increasing Australia’s future prosperity”.

Below are the highlights:

While labour productivity gets much of the focus year on year, it is multifactor productivity (‘doing things better’) that has delivered strong long-run economic growth. But no longer. Since 2004, multi-factor productivity has stalled, here and around the developed world. This is a long enough period to suggest something is seriously awry in the economic fundamentals and the consequent generation of national wealth and individual opportunity.

Australia’s high living standards may not appear under threat from this collapse in productivity. We recently had a decade of commodity price growth and, more recently, inflating housing prices to make us feel wealthier, even if the reality of low wage growth and falling fixed capital investment suggest that a weak income outlook may persist now past the terms of trade decline. And it certainly indicates that incentives to invest and so create the tools and training for the future are weak.

If we were waiting for a crisis to indicate that government should act, there is none — just an inexorable slowing towards reduced opportunity, greater dispute over shares of a smaller than expected pie, and selective protection.

We have strong legacy endowments of resources, a better savings performance than throughout the 1990s and early 2000s and many of us have good skills for today’s work environment. We may well be able to draw down on them for some time yet, unless external factors move adversely. But just as persistent borrowing by government may burden the future, so failure to develop the policies most relevant to future higher productivity — and its outcome, higher income — will burden future generations with the eventual adjustment cost. We saw this last in the 1980s.

Complacency is not a sound policy option. Aside from the productivity collapse itself, the fiscal and labour market effects of population ageing, the potentially sweeping structural changes in labour markets following digital disruption and climate change impacts are all challenges to a slow growing economy. If nothing changes, achieving people’s expectations will prove increasingly difficult and the costs of this may be measured not just in incomes, but in alterations to quality of life…

The ‘nothing era’: what has been happening to productivity?

… the ‘good’ labour productivity outcomes of recent years have almost entirely reflected the contribution of more physical capital, rather than any underlying improvement in the capacity to ‘get more out of all inputs’. That capacity — measured in figure 3 by multifactor productivity growth rates (MFP) — languished from 2003-04, creating what has been referred to as the ‘nothing era’.

ScreenHunter_15960 Nov. 08 08.17

…the ‘tos and fros’ of mining productivity have not been important enough to fully explain the downward shift in economywide MFP growth rates…

ScreenHunter_15961 Nov. 08 08.20

The slowdown in Australia’s capacity to ‘do more with the same’ is puzzling because scientific and technological knowledge advanced rapidly after the early 2000s. Consider that in 2003 there was no Cloud, the ‘internet of things’ or iPhone or any smart phone or tablet (with all their portable apps — mapping, email, messaging, and video services)… Robotics, gene technologies, material science, machine learning, artificial intelligence, sensor technologies, and drones all progressed strongly in this decade. In the period from 2003 to 2015, the share of businesses using the internet increased from 70 to 95 per cent, and the share with a web presence from around 25 to 50 per cent…

There is other compelling evidence that a significant share of Australian businesses have poor management practices, and while this is true for all countries, Australia lags behind the leading countries (figure 5).

ScreenHunter_15962 Nov. 08 08.23

Factors such as competition, ownership, taxation and regulation affect the quality of management by affecting the incentives for better performance and potentially lowering the likelihood of exit by laggards…

Implications of productivity for incomes

The single best indicator of economic prosperity is so-called ‘real net national disposable income’ (RNNDI) per capita because it represents the income available for consumption by Australians (figure 6). In the last seven years, average annual growth was below 0.5 per cent per annum. Indeed, there have been four successive reductions in RNNDI per capita from 2012-13 to 2015-16, the only time a sequence of this kind has been experienced in close to the last six decades. This outcome was strongly associated with the precipitate and (over this period) unparalleled fall in Australia’s terms of trade, abetted by weak productivity growth.

ScreenHunter_15963 Nov. 08 08.28

There are six major ways in which Australian real incomes per capita can increase over time, of which multifactor productivity is only one (figure 7). Understanding these factors throws light on the challenges Australians face in the future:

Productivity — Output can increase without any additional inputs (MFP). Given the low growth rate in MFP, this has contributed very little to real income growth in the last decade.

Participation — Labour inputs can vary per capita (for example, through longer working hours per employee, lower unemployment or higher participation rates). As with MFP, this has played a negligible role in recent income growth. And as population ageing shifts more of the population into ages where participation rates are lower, future reductions in labour inputs per capita appear inevitable, with associated adverse income effects.

Investment — Capital intensity can rise (for example, through infrastructure, buildings and equipment, information technologies and robotics). This has been the most consistent factor behind growing incomes per capita, but its flip side, depreciation, has offset its influence on incomes in the last decade. Investment in human capital, though education, training, and learning by doing, can complement capital and contribute to higher productivity.

ScreenHunter_15964 Nov. 08 08.30

Savings — Net foreign income inflows depend on the past balance between saving and investment and how much Australia relies on foreign borrowing and on the relative returns on these two-way investments. The inflow can increase for any net debt position (for example, if the return on investments held by Australians abroad from dividend and interest income rise relative to the return on foreign investments in Australia). While the inflows have been positive (but modest) in recent years, Australia has relied on financing of investment from overseas, which suggests future negative inflows.

Depreciation — The productive value of older capital reduces over any given period, with the size of this effect depending on the vintage and structure of past capital expenditure. While public infrastructure has long lives and low depreciation rates, many new technologies (particularly information technology investments) have short lives and high depreciation rates. So even with the same rates of investment, the growth in the stock of capital, and hence the services it provides, will be lower.

External price shocks — The buying power of Australian production depends in part on the relative prices of exports to imports (the terms of trade). Growth in the former over the latter translates any given production into a greater capacity to buy imports and higher real incomes (the ‘terms of trade’ effect). Unlike (i) to (v), the terms of trade effects arise from luck…

Looking over the very long run, most of the above six factors cannot drive sustained real income growth. For example, labour inputs per capita cannot increase indefinitely (given the desirable limits to hours worked).

In contrast, MFP has the quality that it is ultimately unbounded. There is no obvious limit to the acquisition of new knowledge, which underpins new products and services.

The historical experiences of Australia and most advanced countries also suggests that investment is likely to remain an important contributor to labour productivity growth and wage increases. Furthermore, since technology is often embedded in capital, higher investment rates can complement skills and innovation, and increase productivity. This means that policies influencing investment will be directly relevant to MFP, making a conducive investment environment doubly important…

It is worth noting that the collapse in Australia’s multifactor productivity over the past 12 years coincides with the massive ramp-up in Australia’s immigration, which is projected to continue for the next 35 years (see next chart).

ScreenHunter_15215 Oct. 02 18.45

While this does not by itself confirm that Australia’s high immigration program has lowered productivity, it is nigh impossible to argue that it has raised it either – a case that is frequently made by population boosters.

It is also interesting to note that not once in the PC’s 30-page report does it mention “immigration”, “migration” or “population growth”, which is also surprising given we are frequently told by the boosters that strong immigration is required to raise prosperity and living standards.

[email protected]

Unconventional Economist
Latest posts by Unconventional Economist (see all)

Comments are hidden for Membership Subscribers only.