Pearls and Irritations

While lifting the rate of productivity growth is the obvious solution to the cost of living crisis, judging by the experience of most developed economies, it is not obvious how to restore productivity growth.

According to the opinion polls the cost-of-living is the dominant political issue. Already it is clear that Dutton wants the focus of next year’s election to be on whether or not we are better off with the Albanese Government, with the clear implication that we are not.

Not surprisingly, there are numerous proposals for economic reform, including some from highly esteemed economists, like former Treasury Secretary, Ken Henry, and Professor Roy Green. Allegedly there is ample scope to reinvigorate the economy and improve equality as well.

But while not denying the worthiness of many of these reform proposals, the starting point should be how badly has the economy been performing and why. We need to consider first if and why the rate of economic growth has slowed, and second how the benefits of economic growth have been distributed.

Australia’s economic growth

The rate of economic growth as measured by real GDP has certainly slowed over the last decade compared with the previous half century. Since the Coalition was returned to office in September 2013, the average annual growth rate in real GDP has been 2.4 per cent, more than a full percentage point less than the average annual growth rate of 3.5 per cent over the more than fifty years between 1959-60 and 2012-13.

Furthermore, economic growth was remarkably stable over that long period, only fluctuating with the business cycle, but its long-term trajectory remained almost unchanged. In addition, the slowdown in economic growth during the most recent decade started at the beginning of that decade and is no better or worse since the Albanese Government was elected in May 2022.

This slowdown in economic growth is almost entirely explained by a fall in the rate of productivity growth. Gross value added per hour worked increased at an average annual rate of 1.7 per cent over the period from 1978-79 to 2012-13 (earlier data are not available) but averaged only a 0.7 per cent annual growth rate over the most recent decade from 2012-13 to 2023-24.

This decline in the rate of productivity growth was general across all the goods producing industries – agriculture, manufacturing, construction and transport. The only exception was mining where productivity growth in the last decade was significantly higher than in the previous three and a half decades. Also, the comparative performance over time of the different service industries varied a lot within that broad sector, but with no general pattern.

So the critical question is why has productivity growth fallen in most of the goods producing industries in the last decade or so?

Why has productivity growth fallen?

In a most interesting and thought-provoking address (summarised in Pearls & Irritations, Nov. 21), Ken Henry argues that China’s emergence as the world’s most important trading nation has reduced the relative prices of labour-intensive products, like manufactures, and increased the relative price of capital-intensive products like minerals and energy.

In Australia this fall in the relative price of labour-intensive products resulted in weak business investment, leading to a deterioration in Australia’s rate of productivity growth. According to Ken Henry’s calculations, “the resources boom explains two-thirds of the deterioration in Australia’s productivity growth performance so far this century.”

It also means that “the living standards of domestic workers have declined relative to the owners of capital.” However, that hasn’t translated into a declining share of wages in gross domestic product, because GDP growth is also negatively impacted by weaker labour productivity growth.

Henry’s conclusion is that rather than pandering to the sectional interests of the extractive industries, much of the stagnation in productivity growth, and consequently living standards, could have been avoided. Instead, tax reforms should have been adopted to ensure a better spread of the benefits from the mining industries’ windfall profits.

In a related analysis, Roy Green (Pearls & Irritations, Nov. 23) argues that the predominance of unprocessed raw materials in Australia’s exports has resulted in an exceptionally narrow trade and industrial structure. Australia is now ranked 102 out of 133 countries in terms of the diversity and knowledge intensity of its export mix, behind Argentina and Bangladesh.

Green’s conclusion is that this narrow industrial structure is the underlying source of the stalled productivity growth and real wage stagnation in Australia.

While I find the analyses by Henry and Green quite persuasive, I am less sure about how significant the impact of the resources industries has been as the source of our lower productivity growth and wage stagnation over the last decade or so.

Through history the rate of innovation and take-up of new technological discoveries has been the main source of productivity growth, and thus increasing living standards. Furthermore, as new innovations tend to spread quite rapidly from their original source to other similar economies, that tends to mean that the rate of productivity growth is usually fairly similar amongst the developed economies.

In understanding Australia’s situation, it is therefore significant that productivity growth has slowed in the last decade or so in most of the developed OECD countries. Indeed, judging by the productivity growth rates reported in Table 1 below, it seems that Australia’s experience of slower productivity growth is much the same as in other developed economies, and productivity growth in these other countries cannot have been affected by a mineral boom.

Furthermore, the obvious explanation for the negligible productivity growth in all countries, except the US, over the last 4 years is the tight monetary and fiscal policies in response to higher inflation. If tax reforms or other government policies could make much difference to the long-term rate of productivity growth then we would expect to see more difference between the experience of different countries.

Table 1 Productivity growth rates compared

Average annual growth rate %

Source: OECD Economic Outlook data base.

Income distribution in the modern era

Apart from slower economic growth there is a widespread view that inequality has also increased, thus intensifying cost-of-living pressures on lower-income households.

In our book, Fair Share, Stephen Bell and I reviewed the evidence and found that inequality of incomes has increased in most developed countries since around the early 1980s.

The principal driver for this increase in inequality was the impact of technological change which concentrated on replacing labour engaged in routine jobs, with the definition of routine jobs expanding over time as new technologies became more sophisticated. This focus on routine jobs meant that it was the middle-level jobs that tended to disappear, and the consequent changes in the job-structure inevitably led to an increase in wage inequality as conventionally measured.

Equally important, however, has been how government policies have responded to the changes in labour demand caused by the new technologies. In those countries, like Australia, which actively embraced retraining and up skilling, to meet the shifts in demand, relative wage rates did not change much if at all. On the other hand, where there was no increase in the supply of skilled workers, as in the US, then wage relativities also increased leading to a much greater impact of technological change on income inequality.

Interestingly, an update of the sort of analysis reported in Fair Share, shows that in Australia the relative earnings of the principal occupation groups have not changed much at all over the last decade (see Table 2). This is consistent with the past finding that any increase in Australian inequality must be due to changes in the job structure of the labour market and not relative earnings.

Conclusion

While we have grown up in a culture where we expect to be better off over time, that is no longer true, and we cannot be sure why not. Unless AI has a bigger impact on productivity, particularly in the service industries than it appears to have had to date, maybe we will need to adapt to a society and values which are less demanding that productivity and living standards should always continue to increase. After all that was the experience of the human race for millennia, and arguably it would be better for the environment as well.

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