Productivity spotlight comes at crucial time

Australia’s productivity, the nation’s capacity to grow its income and living standards, is again under the spotlight, as a result of productivity growth having largely stalled and in the footlights of faltering labour market activity. The latest five yearly review of productivity by the Productivity Commission may be timely, especially as the structure of the economy has changed in recent years.

Largely thanks to the mining construction boom and fuelled by high prices for our mineral resources for several years, Australia’s income growth decoupled from its relationship with productivity growth, as measured by gross domestic product (GDP). You can see this in the chart below, which was extracted from an article by Greg Jericho in The Guardian.

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The dilemma is not the ‘windfall gain’ of the mining boom and the ore prices, it is that in addition to it being unsustainable, the driver of incomes – productivity and growth – have been falling away over the last decade, though it is trending up as the chart below shows, on a five year basis.

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It is noticeable that the chart measures productivity growth in terms of labour and it is here that we have to exercise caution. Many commentators will say that for far too long, Australia’s productivity debate has been mired in conversations about industrial relations, often aided by the way most economists prefer to measure and report productivity – on a unit labour input basis.

The simple fact is that many factors make up productivity, but few other than labour, can be used as the base for measuring the effectiveness of the other measures in contributing to productivity growth.

As Jericho describes it, there are three factors that input to total labour productivity:

The first is “capital deepening” which is essentially the increase of investment in capital per worker. Usually this is broken down into two groups – IT and non-IT, and derives from the assumption that more capital, such as computers or machinery, enables workers to be more productive.

“The second aspect is labour composition which looks at the skill level of workers – under the assumption that more skillful workers will be more productive. 

“The final aspect is multi-factor productivity which looks at the ability of labour to make use of that capital.”

As the Productivity Commission (PC) begins its five yearly review of national productivity, it is the fact of the source of Australia’s productivity growth that seems to be bothering it most.

What has occurred since 2003 is that virtually all of Australia’s labour productivity has been driven by capital deepening and not by multi-factor measures and activities.

The chart below, taken from the Productivity Commission’s discussion paper for the review, focuses on the ‘market sectors’, but holds true across the economy.

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The PC notes that firm level productivity may simply be poor and declining and that the deepening of the capital pool is not translating into improved capacity at the local and detailed level. There could be a lag effect here or it could be that the potential of technological change in all its forms is simply too complex to extract (despite the relative ease of use at a superficial level).

There is insufficient space here to address all of the issues identified by the PC as being of interest, but there are two that need to be considered, albeit in passing. 

The first is the risk of increasing income inequality from an economic, not just a social standpoint, coming about as a result of declining multi-factor productivity and ultimately, a lower capacity to share income widely. That has implications for future investment in labour and in knowledge acquisition and firm level capability. Potentially, that’s a slippery slide to uncompetitiveness.

The second, and its related, is management capability, which in Australia, in general, lags behind the leading countries. The chart below shows Australia’s management performance on a relative basis with other countries and in the third graph, the extent to which management capability explains the proportional gap with US productivity. That final score suggests more than half of the gap is made up of management capabilities.

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Any way you look at it, the productivity debate in Australia has something to concern pretty much everyone. With living standards, social cohesion and future opportunities all at stake, this latest round in the productivity debate should be all about policy that can help drive the future.

The PC review of Australia’s productivity is available for public comment at