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How to stop the productivity time bomb making us poorer

Productivity is normally a slow burn issue but a sharp drop is putting the government, business and home borrowers in the firing line.

John KehoeEconomics editor
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When Treasurer Jim Chalmers visited Wellington last week and met Reserve Bank of New Zealand governor Adrian Orr, he would have gained a first-hand insight into what happens when inflation and wages run too hot.

New Zealand’s official interest rate of 5.5 per cent is sharply higher than Australia’s 4.1 per cent cash rate after the RBA’s 12th rate increase in 13 meetings on Tuesday.

Treasurer Jim Chalmers says there is no quick fix to the productivity challenge.  Peter Rae

RBA governor Philip Lowe warned that unless Australia’s abysmal productivity picked up, higher wages would put upward pressure on inflation and interest rates.

Productivity – how efficiently labour produces goods and services – is the secret sauce of prosperity. Better ways of producing the same output with fewer inputs accounted for more than 80 per cent of national income growth over the past 30 years, according to the Productivity Commission.

But productivity growth has slumped to a 60-year low over the past decade and productivity has gone backwards during the pandemic to 2019 levels. The gravity of the problem has been masked by the mining boom pushing up national income and surging immigration adding to GDP.

Chalmers says the productivity challenge has been building for years and “you can’t click your fingers and make it turn around overnight”. This is largely true.

But many economists believe Labor is making the problem worse by imposing new union-friendly regulations on workplaces.

The government has identified policies on the energy transition, investments in skills and technology adaption as core to its productivity agenda.

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But economists and business leaders argue this small-target agenda, largely devised in opposition before the election and before the full extent of the inflation problem was realised, is not ambitious enough to jump-start weak productivity inherited from the Coalition.

Unless government, business and workers rectify the problem, real incomes will suffer, living standards will stall and inflation pressures will persist.

One of Australia’s leading productivity experts, e61 Institute program director Dan Andrews, says Australia has a “serious productivity problem”.

“Productivity is normally a slow burn issue, but now the chickens are coming home to roost because it’s starting to hit people’s hip pocket and the central bank is in a very sticky situation,” says Andrews, a former head of structural reform at the Organisation for Economic Co-operation and Development in Paris. “There is an opportunity here for the government to explain how they’re going to address this.”

The many faces of productivity

Australia has dropped from one of the standout global productivity performers in the 1990s to a laggard today due to a range of short and long-term local and international factors.

Pandemic interruptions from clogged supply chains, labour shortages and delayed business investment identified by Lowe may explain the unprecedented 4.5 per cent fall in output per hour worked over the year to March 31.

What politicians and central bankers can talk less openly about is that the ultra-low unemployment rate of about 3.5 per cent is a likely contributor.

The tight labour market is sucking in less skilled and less experienced workers. More long-term unemployed and youths getting jobs is a good social outcome. But the downside is they may be producing less output per hour of work than experienced workers.

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Moreover, skills shortages may be causing the “hoarding” of marginal workers because they are so hard to attract and retain.

Work-from-home could also be contributing to weaker productivity Wesfarmers boss Rob Scott suspects, although nobody is really sure. It may depend on the types of jobs and industries. Chalmers downplayed the work-from-home impact.

Wesfarmers CEO Rob Scott is sceptical about the productivity benefits of working from home. Dominic Lorrimer

Nevertheless, these are short-term trends that may correct as the pandemic passes, the economy slows in response to higher interest rates and the unemployment rate ticks higher.

The medium-term economic and social forces weakening productivity growth for more than a decade under Coalition and Labor governments are arguably more deep-seated.

Internationally, productivity has been deteriorating as economies mature and populations age. Wealthy economies are shifting away from manufacturing to lower productivity services such as aged care, healthcare, disability care and personal services such as massage and beauty. Labor wants to improve the so-called “care economy”. That won’t be easy in a government-dominated and regulated sector.

Productivity gains in labour-intensive services are harder to deliver compared to manufacturing, where machines can produce more output as technology advances.

Moreover, it is challenging to measure productivity in services – both in terms of quantity of output and the quality. For example, improvements in medical technology to replace a knee won’t necessarily be captured in productivity data, even if an operation gives a higher quality of life for more years.

Weak business investment

But this alone doesn’t explain why Australia’s performance has been so bad. Most economists and many business leaders agree the chief cause of poor productivity in Australia is chronically weak business investment.

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The climate and energy policy wars of the past 15 years have probably contributed to investment uncertainty for business, while more recently Labor’s energy price caps and gas interventions also have not helped.

Investment in new machines, equipment, tools and technology allows workers to produce goods and services more efficiently. Output per hour rises and the income gains are shared between firms and workers. That’s what happened under the Hawke, Keating and Howard governments in the 1980s and 1990s during the “reform era”.

Former prime minister Bob Hawke and then treasurer Paul Keating ushered in a suite of reforms. Peter Morris

Since then, non-mining business investment as a share of the economy has fallen over the past two decades by about 2 per cent of GDP – a huge $50 billion a year in today’s dollars.

Former Treasury secretary Ken Henry blames the chronically weak non-mining business investment on the resources boom curse. China’s insatiable demand for Australia’s iron ore, coal and gas has pushed up commodity prices and sucked in foreign capital to expand the mining sector.

Foreign inflows contributed to the real exchange rate appreciating by about 50 per cent over the 20 years to 2019 before the pandemic. Mining also poached capital and labour from other industries and pushed up costs.

Henry says the loss of international competitiveness killed non-mining investment in other industries such as manufacturing, finance and services. Productivity plunged and GDP per capita growth fell to levels only typically recorded in recessions.

The two-speed economy is why Henry has advocated for a stronger resource rent tax to collect more revenue to help fund a cut in the 30 per cent company tax rate to 25 per cent. It would make non-mining businesses more competitive, boost investment, lift productivity and increase real incomes.

An attempt to impose a resource super profits tax by the Rudd government in 2010 failed. The corporate tax reduction was limited to small companies under the Coalition government.

More broadly, Henry said in a speech in March that rather than continuing to heavily tax workers, particularly younger people through “stealth” income tax bracket creep, federal and state governments needed to follow the “big bang” tax reform successes of the Hawke-Keating and Howard governments.

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Taxing consumption, land, natural resources, windfall profits of big companies and carbon emissions could pay for lighter taxation of labour income, normal-sized business profits and removing stamp duty.

Australia’s tax system is “incentive-killing”, former productivity commissioner Gary Banks said this week.

Chalmers has vowed to “renew” the commission and is advertising for a new chairman following Michael Brennan’s announcement that he will step down in September after five years.

Banks warns that Australians will miss out on a $10,000 pay rise unless Chalmers stops “shooting the messenger”. He urged the treasurer not to dismiss the commission’s recommendations such as on energy and liberalising workplace relations, the latter which Chalmers has derided as “scorched earth” policies.

RBA governor Philip Lowe blames low productivity for inflation.  Louise Kennerley

“Raising Australia’s productivity growth would not only ameliorate our current fiscal difficulties and take some of the pressure off taxes and spending; it would help secure the holy grail of economic policy: namely, non-inflationary, real, wage growth,” Banks said in a speech.

“What the Treasurer left unsaid was whether we can do that will depend above all on the policy settings that condition business decision-making and the allocation of the nation’s resources.”

Business ultimately delivers productivity at the firm level. But governments – federal and state – set the policy conditions for how businesses organise themselves by investing, competing and hiring.

Worryingly, Australia’s economy and businesses are becoming less dynamic, according to a growing body of research from Treasury, the RBA, OECD, e61 Institute and the Committee for Economic Development of Australia.

Many local businesses have not kept pace with leading firms overseas in adopting emerging technologies. The divergence in technology and innovation between global frontier firms, such as miners like BHP, and laggards has widened – dragging down overall productivity.

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The substandard management and technology skills of Australian executives may be contributing to the nation’s waning innovation, the Productivity Commission has warned.

The OECD estimates that the productivity gains from upskilling managers could be three times higher than for upskilling workers.

The pandemic forced companies to adopt new technologies to accommodate work from home and e-commerce. But there are doubts that firms are effectively diffusing emerging technologies such as artificial intelligence, cloud computing and blockchain.

Companies may be complacent. In a potential sign of a failure of competition, big companies are remaining at the top for longer and there has been a decline in the number of new firms starting up to disrupt incumbents.

Australia’s top ASX companies such as miners, banks, Telstra, insurers and supermarkets look remarkably similar as 20 years ago, compared to America’s stockmarket being disrupted by technology companies.

Moreover, workers have been switching jobs less, impeding the reallocation of resources from incumbents to faster-growing start-ups. These issues are being explored by a parliamentary economics committee led by Labor MP and PhD economist Daniel Mulino.

Workers have been switching jobs less, contributing to productivity problems. Jason South

There are two diverging theories. Red tape and other regulatory barriers such as tax and industrial relations may be impeding competitive disruption. The Productivity Commission view has traditionally been that, as a medium, open economy with a relatively small population spread across a large land mass, Australia may only be able to accommodate a select number of big firms in a sector. Maintaining openness to foreign trade and investment ensures competition.

But others, such as the OECD and former competition watchdog Rod Sims, believe oligopolies do not face enough competition and have become too cosseted. ACCC chairwoman Gina Cass-Gottlieb wants tougher competition laws to require companies to gain formal clearance before pursuing any mergers. She wants broader powers to stop mergers, including over deals that entrenched existing market power.

Chalmers is receptive and the idea also has support from Assistant Treasury Minister Andrew Leigh, who is championing greater competition.

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E61’s Andrews says the government will need to overcome more than a decade of “reform fatigue” to get on the front foot in several policy areas. “The government needs to reposition itself.”

If Labor is not prepared to move on tax and industrial relations to enhance productivity, Andrews says the government should focus on competition and skills including migration reforms.

He also advocates removing barriers for workers to switch firms to allow the reallocation of labour by freeing up occupational licensing across state borders, fixing housing supply and removing state stamp duty on home purchases, and banning non-compete clauses for workers wanting to move to rival firms.

“Things that boost skills, break the shackles of worker mobility and create more competitive markets are good for productivity and wages, and there is no growth-equity trade-off,” Andrews says.

“If we’d actually expanded the supply capacity of the economy over the past 15 years, there would be less inflation.”

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John Kehoe
John KehoeEconomics editorJohn Kehoe is Economics editor at Parliament House, Canberra. He writes on economics, politics and business. John was Washington correspondent covering Donald Trump’s election. He joined the Financial Review in 2008 from Treasury. Connect with John on Twitter. Email John at jkehoe@afr.com

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