Keeping Australia productive after the boom

Author: Jenny Gordon, Australian Productivity Commission

Australia’s 2015 Intergenerational Report assumed that labour productivity would grow at an average annual rate of 1.5 per cent over the period 2015 to 2055. This is slightly lower than the growth in labour productivity over the last decade because multifactor productivity has stagnated.

The market boards show the volatility at the Australian Securities Exchange (ASX) in Sydney. (Photo: AAP)With the boost in income growth from the terms of trade coming to an end, labour productivity growth will be the primary driver of future income growth. And as capital investment growth is likely to slow with the end of the mining boom, restoring multifactor productivity growth will be critical to delivering on even this more modest labour productivity growth projection.

An easing of Australia’s productivity growth since the 1990s was to be expected, but the ongoing deterioration is a concern.

Some of the sources of the recent poor productivity performance are temporary. This includes the effect on agriculture and water service utilities of drought, and the lag in capital investments coming online in mining and some utilities. While capital is counted in productivity statistics at the point of investment, large capital projects can take some time to be fully utilised. So where investment in large projects is accelerating, as in the mining boom up until 2012, utilisation will increasingly lag investment, appearing as poor productivity growth.

Some of the sources of recent poor productivity growth are more systemic. As mining resources are depleted and environmental services come under increasing pressure, productivity is negatively affected. More purchased inputs are needed to maintain production. Such higher costs of production come as the ‘free’ environmental inputs decline, due to depletion or a community desire to protect what is left.

Another source of poor productivity growth is more speculative. It appears that consumers are managing to capture productivity improvements provided by completely new products with new functionality. With models for how to monetise new technologies, such as Google search and Twitter, still developing, nominal GDP growth will lag behind the growth in value to consumers.

So what are the prospects for productivity growth? Disruptive technologies offer exciting but uncertain prospects. Digital platform technologies, such as UberX and Airbnb, enable greater utilisation of a range of assets, including household cars and homes. Data are a growing resource that can be mined for new value-adding services. Just how disruptive technologies will impact on nominal GDP is uncertain, partly because of the potential for consumers to capture much of the benefits, and as these technologies increase the potential for more activity to take place outside the formal economy.

Australia faces some long-term challenges to productivity. The good news is that even if it does not fully appear in productivity statistics, the benefits from higher quality products can compensate consumers for slower wage growth. For governments, there is also good news in that capital utilisation rates should rise, if slowly, in mining and some utility sectors.

There is also less welcome news. The depletion effect on natural resources will continue to increase the real cost of production for many industries. Climate change will affect agricultural and utility productivity over time. Regulation to protect the environment comes with a productivity cost, while failure to protect the environment can impose costs to future productivity through the deterioration in the quality of natural resource inputs.

Preferences for non-market outcomes could see a shift in Australia’s output mix toward production that sacrifices some market efficiency for more of the non-market product. Like quality for consumers, this trade-off is welfare enhancing, but it does not necessarily add to nominal GDP or measured productivity.

But there are opportunities. The most obvious is to better utilise investments in education and skills by raising labour force participation rates and hours worked, particularly for mothers and older workers, but also for youth. The government can also make and encourage wise public and private investments in education, infrastructure, and research and development.

But investment alone does not deliver productivity growth. Investment in infrastructure tends to go to major projects, often with uncertain utilisation, long build times and associated capital lags. Investments should be based on cost–benefit assessments, aligning incentives and risk with the capacity to control and regulate.

Sustainable government revenue is key to sustainable funding of government services. Yet growth in nominal GDP, on which the tax base depends, may settle at below previous historical rates. And, to the extent that the tax revenue base relies more on wage income and consumption, the trend over the last decade of a falling labour share of income will also affect revenue. Governments are likely to face a choice of changing how they raise tax revenue or substantially lowering their funding for services.

This makes it even more imperative to improve productivity in the delivery of human services — particularly education, health and social services — which are a growing share of the Australian economy.

Empowering consumers to drive welfare-enhancing market solutions through client-directed subsidies can play a role. But such mechanisms can have unintended consequences and affect equity. And there are areas of human services where markets will not provide solutions, so caution is needed.

Effort on many fronts will be required to improve Australia’s productivity, not least in human services and public infrastructure investment. Progress requires the support of the public and acceptance that trade-offs have to be made to better align incentives for productivity improvements with the decisions that people, firms and government have to make about their consumption, labour supply and investment now and for the future.

Jenny Gordon is Principal Adviser (Research) at the Australian Productivity Commission. The views expressed in this article are those of the author and do not necessarily reflect those of the Productivity Commission.

An extended version of this article was published in the most recent edition of the East Asia Forum Quarterly, ‘Asia’s Intergenerational Challenges.