Michael Keating. Improving Productivity.

Fairness, Opportunity and Security
Policy series edited by Michael Keating and John Menadue.

After more than seventy years of ever increasing living standards Australians have come to expect further such increases as their right. But these increasing living standards are for the most part dependent on increases in productivity. So as Nobel Prize winner, Paul Krugman put it, while productivity may not be everything, it is just about everything.

Unfortunately in the last decade Australia’s productivity growth has slowed compared with the 1990s when it accelerated, probably partly in response to the micro-economic reforms of the 1980s and 1990s. Perhaps for that reason business and a lot of the commentariat seem to think that productivity improvement requires more micro-economic reform; to the point where commitment to micro-economic reform is becoming a litmus test of ‘good government’.

Furthermore, business’ definition of more micro-economic reform focuses principally upon reforms of tax and workplace relations. However, taxation and workplace relations legislation are highly contentious policy areas; indeed they represent the two most amended areas of Commonwealth legislation since Federation, reflecting key ideological differences in the traditional political divide between labour and capital. So reform of taxation and industrial relations is especially contested, as is any possible impact on productivity.

Less contested are the frequent demands for more infrastructure investment, including from those like the Reserve Bank who should know better. The reality is that too often infrastructure is seen as a free good, with remarkably little concern for whether such investment is warranted. More relevant for future productivity, as the recent Review of Competition Policy has reminded us, is that micro-economic reform in the past was principally about increasing competition.

Accordingly this article explores what drives increases in productivity, what is the likely outlook for productivity and what difference can policy make to that rate of productivity increase. In particular, it will be important to ascertain what proposals for so-called micro economic reform are really in the public interest and what mainly reflect the self-interest of the proponents.

Technological progress

Through history economic transformations and the associated productivity gains have been almost entirely in response to technological progress. The Stone Age was characterised by the technology of that Age, and all progress since then reflects new technologies, such as the invention of printing, new modes of transport and power, weapons etc., right up to the present impact of ICT. So the starting point for increasing productivity would logically be to consider the scope for accelerating the pace of technological change.

Of course, the differences in the technology levels experienced in different countries reminds us that institutions and policies can make a difference to the rate of adoption and adaptation to new technologies. So there is potentially a role for government to encourage and facilitate the rate of technological progress. Nevertheless, this role is less when a country, like Australia, is at or close to the global technology frontier and has limited scope to catch-up on others.

Furthermore, in this century productivity (at least as measured) seems to be slowing down, not only in Australia, but also in most of the other advanced economies. This slower productivity growth could in turn be consistent with a lower rate of global technological progress, making it more difficult for Australian government policy to engender faster productivity growth in the next decade or so.

What drives technological progress and its adoption

The key drivers of technological change are in fact familiar, as are the policies that can underpin these drivers, although they do not always receive due recognition by government and business.

First, continuing government investment and support for both public and private research and development is critical, as the economic returns are slow to be realised and difficult to appropriate. Even though most innovations are global, unless Australia is engaged directly in research we risk being slow adopters of new technologies. In addition, governments can play a role in encouraging closer links between researchers and industry, through the CSIRO and programs such as the Cooperative Research Centres which are jointly funded and managed by government, business and academia. It is therefore of considerable concern that government funding for research and development, and for the CSIRO and the Cooperative Research Centres have been substantially cut in recent years.

Second, skills are critical to the adoption and adaptation to new technologies. Governments need to foster a high degree of technological literacy and the necessary knowledge and skills to ensure the rapid adoption and use of externally developed technology.

Third, technology creation is not just the product of professional technologists or technology companies. We also need a workforce that is trained to use new technologies effectively, and productivity will be enhanced if our workers can quickly adapt to the use of new technologies. But too much of present-day training is highly specific to today’s jobs, making that adaptation more difficult. Workers also need more generic skills that allow them to understand better how and why technology works, rather than just being able to follow the manual and/or relying on experience. Instead training structures and content should provide them with the adaptability skills to allow them to quickly and effectively use the new technologies that will characterise tomorrow’s jobs.

Again it is of concern that in recent years the funding for tertiary education and training have also been cut substantially. The risks to future productivity growth are considerable, and all these cuts risk proving to be false economies as lower economic growth may further reduce Australia’s long-run fiscal sustainability.

Fourth, new technologies often require re-organisation of a firm’s business model and organisational structures, so that the quality of management makes a difference to the adoption and adaptation to new productivity-boosting technologies. The government’s programs of assistance to small business can help inform management of changes necessary to adapt to new technologies and the re-skilling that their firms will need to undertake. The impact of labour market regulation on the capacity of management to pursue changes in the organisation of work is also potentially important, and will be further considered in a discussion of labour market reform below.

The role and impact of micro-economic reforms

So given the over-whelming importance of technological progress for future productivity growth, what might be the impact of the various micro-economic reforms proposed and as listed briefly above.

Competition policy is the most important of these reforms. Competition is a significant driver of technological progress as firms strive to obtain a competitive advantage by developing and quickly adopting new technologies. Even within the boundaries of existing technologies competition typically provides the key impetus to increase efficiency which is then reflected in productivity gains. The recent report of the Competition Policy Review, by the Harper Committee, provides an authorative list of desirable reforms, of which the three with the greatest likely impact on our economic performance are:

  1. Establishing choice and contestability in government provision of human services can both improve the quality of the services by empowering service users, and improve productivity at the same time. Progress along these lines is already being made for some government funded services, and in some instances costs have been driven down. One problem, however, is that the experience so far is that the service users do not always have adequate information to make a fully informed choice, and consequently the quality of service provision can deteriorate unless there are good regulatory systems.
  1. Ensuring cost-reflective pricing of infrastructure would improve the efficiency of use of much infrastructure and would encourage better investment appraisal of future infrastructure proposals. By contrast, at present many uneconomic infrastructure investments gain approval, and represent a waste of scarce savings. Roads are the worst offender, but as recognised by the Harper Committee, reforms begun in electricity and gas need to be finalised and water reform needs to be reinvigorated. These issues will be discussed at greater length in another article on Infrastructure to be published in this policy series.
  1. Using pricing or other signals to guide the allocation of our land and other natural resources towards their highest-value use, and in this context ensuring that planning, zoning and environmental regulations are applied sensibly.

Each of these reforms proposed by the Harper Committee to competition policy could improve Australia’s economic performance and quality of living standards into the future. However, they would not necessarily show up as an increase in labour productivity, at least as measured.

Workplace relations

Workplace relations, and particularly how work is organised in the workplace, can make a difference to the productivity of that workplace. Cooperation and trust based on fairness will provide a foundation for flexible workplace relations that will help ensure the most effective use of the firm’s existing capital and will also encourage new innovations and accelerate their adoption. The key question is, however, to what extent does Australia’s present system of workplace relations need yet another round of reforms and what can we expect from more such reform?

In 2012 the leading labour market economist, Professor Jeff Borland made the most exhaustive examination available of the impact of the various industrial relations reforms (Work Choices and Fair Work) in the 2000s. After considering the evidence on wages growth and earnings inequality, labour market adjustment, labour productivity growth and industrial disputes, Borland concluded that there was “Little evidence … of an effect from the industrial relations reforms made in the 2000s”. By contrast he did find “some evidence of an effect from the reforms to Australia’s industrial relations system that occurred in the 1990s”, when Australia switched from a centralised arbitration system of industrial relations in favour of enterprise-based bargaining. In Borland’s view “the limited effects of the reforms in the 2000s can be explained by the nature of those reforms – being primarily oriented to changing the relative bargaining power of employers and employees, rather than enhancing overall economic performance”.

Similarly the independent and comprehensive review of the Fair Work Act, also in 2012, found that “since the Fair Work Act came into force important outcomes such as wages growth, industrial disputation, the responsiveness of wages to supply and demand, the rate of employment growth and the flexibility of work patterns have been favourable to Australia’s continuing prosperity, as indeed they have been since the transition away from arbitration two decades ago”. While that review was concerned by the slower rate of productivity growth, it was “not persuaded that the legislative framework for industrial relations accounts for this productivity slowdown”.

Indeed there seems little doubt that since the advent of enterprise bargaining, Australia does have a more flexible industrial relations system. The then Secretary of the Treasury commented that “if it were not for our flexibility … Australia could not have avoided the worst of the impacts of the Global Financial Crisis’. More recently the evidence shows that relative wages adjusted quickly and flexibly to accommodate the increased demands by the mining and construction industries associated with the resources boom and without any upward pressure on inflation more generally. Equally the proponents of further system changes have not yet shown that changes in work organisation cannot be readily negotiated within the existing framework, so long as they are not a blatant attempt to reduce workers’ pay.

So in the light of all the evidence what exactly is another round of changes to the industrial relations system meant to achieve? Such changes are hardly likely to directly increase productivity. Instead the business agenda for workplace relations reform seems to be to provide a cover for cost-cutting rather than increasing productivity. As Borland puts it recent reforms and those now being proposed are “primarily oriented at distributive goals rather than efficiency goals. This leads him to conclude that “private interest can explain current lobbying for further reforms to Australia’s industrial relations system”.

Accordingly Borland’s end conclusion seems eminently sensible that “reform of Australia’s industrial relations system should not be an area of policy-making priority for governments”. Instead what does need improvement is how employers manage and organise the work to use their employees’ skills most productively. Too often employees report dissatisfaction that their skills are being under-utilised, and that the work could be organised more productively by allowing greater autonomy and discretion to individual employees and teams.

There are also problems in industries such as health where traditional demarcations need to be broken down and multi-skilling, broad-banding of positions, up-skilling and team work increased. John Menadue (postings 25 & 27 January) has shown how this would bring substantial productivity gains by releasing high-level specialist staff to focus on the tasks that only they can do.

But none of these improvements in how work is organised require changes to the workplace relations system; rather they require better management. Indeed, the fact that there are examples of such successful re-organisation strongly suggests that regulatory system does allow managers to manage productively. To the limited extent that it can, the government should therefore be encouraging this sort of better management, rather than forever tinkering with the legislative framework for workplace relations.

Tax reform

There may well be other reasons why Australia’s tax system could be improved, but any changes are likely to have only a marginal impact on productivity. Indeed the evidence suggests no correlation between actual levels of taxation and per capita GDP; one reason being because any such analysis fails to take account of how those taxes were spent.

To the extent that present Australian taxes do affect productivity, it is probably because of how they affect the allocation of savings and investment, and not so much through their impact on incentives to invest or work.

Tax reform was addressed further in another article in this series, but suffice to say that most tax proposals have distributional goals or at least distributional consequences, and thus often reflect self-interest, even if that is masquerading as in the public interest.

Conclusion

Productivity is mainly determined by technology and its use. In a globalised world there is only a limited influence of a national government like Australia’s to influence the development of new technologies and their adoption. Most important is the creation of an innovative culture through support for research, development and education and training, and forging closer links between the scientific communities and industry. On the recent record, with substantial budget cuts, there is plenty of room for improvement. Further micro-economic reforms should also be pursued where they have merits, with a focus on competition policy.

More generally, it seems quite possible that living standards in all the advanced economies, including Australia, will rise more slowly over the next few decades than over the sixty years leading up to the Global Financial Crisis. Accordingly a key policy responsibility will be to change popular expectations if they have to adjust to this new reality. And in that case overselling what can be expected from micro-economic reform will only exacerbate this adjustment problem.

Michael Keating AC was formerly Secretary of Department of Finance and Secretary Prime Minister and Cabinet

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