Reforming the productivity commission

Jan 27, 2023
Businessman analysing economic growth graph financial data on tablet. Image: iStock

As federal Treasurer Jim Chalmers ponders the future of Australia’s Productivity Commission (PC), calls for its reform or even abolition have grown louder. Anyone following the media commentary might have the impression that its recommendations have been steadfastly ignored by government for the last two decades.

But it’s arguable that the PC and its predecessor Industries Assistance Commission have been phenomenally successful in realising their objectives. Let’s tick them off. The big win was the end of “protection all round” with virtually zero tariffs on imports, combined with deregulation of capital and labour markets, including decentralisation of wage bargaining for most workers.

While few would deny that the extent of protection in post-war boom Australia had begun to stifle industrial innovation, as well as impacting consumer welfare, its almost complete elimination paved the way for the destruction of our manufacturing capability and its replacement by a narrower, more precarious commodity-based economy.

The latest Harvard Atlas of Economic Complexity, which measures the diversity and research intensity of exports, has Australia at 91 out of 133 countries, just ahead of Namibia. Our developed economy lifestyle, maintained by the export of unprocessed raw materials, now masks a hollowed out “third world” industrial structure, with the manufacturing trade deficit doubling to over $180 billion.

Additionally, “microeconomic reform” mandated the privatisation of almost all profitable government enterprises, public-private partnerships in areas such as toll roads, and the contracting out of remaining government functions that require full or partial taxpayer subsidy, including vocational education, aged care, hospitals, pathology, child care, public transport and prisons.

These changes were made to promote “productivity-enhancing” competition, with resource flows directed by price signals, imposing market discipline on firms, workers and governments. By 2017, the PC was able to declare that “Australia is a substantially market-based economy”, with a narrowing of our self-conception of the state among politicians, senior public servants and the media.

In effect, the Commission resurrected the 19th century Ricardian principle of “comparative advantage”, with a reliance on “natural endowments” such as iron ore, fossil fuels and increasingly “critical minerals” such as lithium. This approach, with no real interest in value adding, has come to dominate the thinking of government central agencies.

Meanwhile, more contemporary approaches to innovation and industrial policy adopted by successful advanced economies around the world are dismissed as self-evidently outmoded and wrong. These are designed instead to build “competitive advantage” through measures to influence the industry composition of output, particularly in complex, knowledge-based activities, and lift the performance of firms and national productivity.

Such approaches are disparaged by the PC and its supporters as “picking winners”, “rent-seeking”, inducing “market distortions”, subject to “unintended consequences”, “misallocating resources” and claims that “government failure is worse than market failure”.

Take the current example of battery manufacturing for electric vehicles and transmission storage. We have made the case elsewhere for policy intervention to promote domestic production and active participation in global value chains.

While Australia produces over half the world’s lithium, we capture only 0.53 per cent of its final value, thus (once again) potentially excluding ourselves from an international growth industry. This is clearly an area of interest for the Albanese Labor Government, particularly Industry and Science Minister Ed Husic.

Yet in a recent submission, the PC could not even bring itself to support modest tax concessions to encourage the take-up of electric vehicles by Australian consumers. At the same time, seemingly it has no problem with the longstanding Diesel Fuel Tax Rebate, which costs the taxpayer $7.9 billion a year, more than half total Commonwealth expenditure on research and innovation.

Acceptance of this outcome reflects the fact that industrial policy as a function of government has been relentlessly diminished, so much so that the federal Industry Department has had to endure eight ministers in the last nine years, indeed nine ministers if we count the former Prime Minister’s foray into the portfolio.

Bureaucratic competence to design and implement policies is now enfeebled to the point where it is increasingly contracted out to the Big 4 consulting firms. And let’s not forget that these are the same firms that got rich in the 1990s modelling the gains to be had by marginalising industrial policy.

So now having accomplished a revolution in policy and ideas, why does the PC need to count on such strident support from its media cheer squad whenever its authority is challenged? Surely its success in becoming the “conventional wisdom” for Australian policy-makers should be justified by the economic numbers.

Here its supporters confront two awkward facts. First, as the economist John Quiggin pointed out nearly two decades ago, the “golden age of productivity growth” lasted only five years, during the latter half of the 1990s. Second, since then it has all been downhill.

As former Commission chair Gary Banks lamented, “Since 2003, the average [annual productivity growth] has hardly exceeded 1 per cent”. Even in the context of a global productivity slowdown, Australia has fallen behind most comparable OECD economies. Embarrassingly, productivity growth in the antediluvian pre-reform period was better.

Without irony, the PC proudly proclaimed in 1999 that “growth in average [real] incomes in the 1990s is back to rates last achieved in the 1950s and 1960s”. Hold on, wasn’t this the same period pilloried as having active industry intervention, centralised wage fixation and public ownership of banks, insurance and infrastructure?

As Quiggin explained, the 5-year productivity “surge” at that time was due to reduced investment, job cuts and work intensification. Private investors needed to recoup the often excessive prices paid for privatised infrastructure assets. Such productivity gains could only be temporary, as investment and jobs rose in later decades.

Separately, the mining industry maximised revenues and profits by massively boosting investment to exploit rising mineral prices and demand. This was, and is, a market that inverts the economic orthodoxy of diminishing returns to scale, rising cost curves and lower prices with increased supply.

Measured productivity in mining has since plummeted, much to the consternation of the PC. But again, despite poor productivity performance and against orthodoxy, mining profits rose exponentially.

It gets worse, much worse. Not only has productivity been limp for decades but recent research by federal Treasury indicates that since 2000 a “range of metrics point towards declining competitive pressures in Australia”. Industry concentration and “market power” – the ability to set prices above costs of production – have increased.

Treasury concludes that “the decline in competitive pressure appears to have weighed on aggregate productivity growth”. Instead of “reforms” intensifying business competition, the exact opposite has occurred.

The PC now concedes that the privatised electricity market “is an appalling mess”, port monopolies are “impeding economically efficient outcomes” and the contracted out “vocational education and training system… is in disarray”. Growing corporate power is also a factor behind the shift of national income from wages to capital and flat real wages.

To explain away this dismal performance, the PC blames ongoing government “regulation”. Apparently, the fact that large firms will “game” the regulatory system and that its own push for deregulation has neutered regulators comes as a revelation.

For the PC, it’s not a naïve textbook “static equilibrium” model that has got us into this mess. Rather, we will always be asked to blame someone else. However, interestingly, when the assumptions of the model are changed to reflect a more dynamic system, as directed by a 2008 industry review, the effectiveness of a more interventionist approach is immediately evident.

There is, of course, a sound rationale for independent advisory bodies to government. The Hawke-Keating government established the Economic Planning Advisory Council, the Bureau of Industry Economics and the Australian Manufacturing Council, among others, all of which provided at least a semblance of competition to the PC.

However, such competition no longer exists, as these bodies were dismantled by successive governments as part of a relentless campaign of central agency “groupthink”. How paradoxical that the PC was left standing as an unchallenged monopoly provider of advice, now ranging freely over vast swathes of economic and social policy.

Clearly, if the Productivity Commission is to be retained, it cannot be in its present formulation. At the very least, a new charter is needed to recognise the pivotal role of industrial policy in the development of a competitive and dynamic knowledge-driven economy.

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