Wake up

“Productivity”, wrote American economist Paul Krugman in 1991 (before he became more-widely known for his acerbic columns in the New York Times and for winning a Nobel Prize), “isn’t everything, but in the long run, it’s almost everything”. What he meant was that productivity – what businesses and government agencies, and ultimately entire economies, get by way of goods and services for each bit of labour and capital that they put in – is the principal determinant of individuals’, and nations’, material living standards; and that productivity growth is the only sustainable source of improvements in individuals’ and nations’ living standards over long periods of time.

Australia’s emergence during the 1990s as a “miracle economy” (another one of Paul Krugman’s phrases) was built upon a dramatic improvement in our productivity performance. From a rather dismal long-run average of just over 1½% per annum, Australia lifted its rate of labour productivity growth to more than 3% per annum in the second half of the 1990s. This achievement was, in large part, the result of a wide-ranging set of reforms designed to prompt firms and (in some cases) government agencies to improve their productivity performance by exposing them to more competition, both from home and abroad.

Over the past decade, however, Australia’s productivity performance has deteriorated dramatically. Labour productivity growth slowed to around 1% per annum during the second half of the 2000s, while “multi-factor” productivity growth (which measures changes in the efficiency with which labour and capital are combined to produce goods and services) actually declined during this period. Measured relative to the United States (as a rough proxy for “best practice”), Australia’s labour productivity fell from a peak of nearly 92% in the late 1990s to just over 84% in 2010 – the lowest since the early 1970s. All of the improvement in our relative productivity performance produced by the reforms of the late 1980s and 1990s has disappeared.

The consequences of this dramatic turnaround in our productivity performance have been almost invisible to Australians, because they’ve been more than offset by the income gains accruing from the most sustained improvement in our “terms of trade” (the ratio of export prices to import prices) in more than a century, the result of the impact of the industrialization and urbanization of China and India on the prices we get for our commodity exports, by our success in weathering the global financial crisis, and by a surge in population growth.

In that sense, there’s an echo of the “lucky country” era of the 1950s, 1960s and early 1970s, when Australia rode the post-war population boom and the industrialization of Japan, and sought to insulate ourselves from the consequences of our deteriorating productivity performance behind ever-rising barriers to trade. Those consequences became starkly apparent when the post-war baby boom faded, and Japan’s industrialization was completed, during the mid-1970s.

Noone can say with any real confidence when the current “resources boom” will end. All we know is that, one day, it will. And when it does, the consequences of the steady decline in our productivity performance will become as starkly apparent as they did in the second half of the 1970s, if we don’t do something about reversing it.

There’s a dangerous complacency in government circles that the deterioration in our productivity performance over the past decade can be attributed largely to peculiar happenings in the mining and utilities sector.

To be sure, measured productivity in those two sectors has fallen sharply, in part because of the long time lags involved in bringing large resource projects to their full production stage; because high prices for minerals make it profitable to extract low-grade ores; and because of the investment (of both labour and capital) deemed necessary to increase the proportion of Australia’s energy coming from renewables, and to ensure longer-term security of urban water supplies by building expensive desalination plants.

But according to calculations published in a report from the Grattan Institute, Australia’s Productivity Challenge (co-authored by this writer), these developments account for less than one-tenth of the decline in Australia’s labour productivity growth rate over the past decade. This report argues that the real culprits are the absence of any meaningful productivity-enhancing reforms over the past decade; the wave of productivity-stifling regulation, much of it in the name of “security” or “corporate governance” which has occurred instead; the effect of the relative buoyancy in corporate profitability over the past decade on the imperatives facing business to seek out productivity gains; shortages of skilled labour and infrastructure bottlenecks, increasingly encountered as the Australian economy has moved closer to “full employment”; and a decline (at least relative to other countries) in Australia’s take-up of productivity-enhancing new technologies.

In response, Australia needs a re-invigorated approach to economic reform; a change in the mind-set that looks to government to regulate the risk out of every form of human activity; a determined focus on improving the quality and reach of our education and training systems; a better system of governance for our infrastructure investments; and a substantially improved national innovation effort.

There’s a saying that history never repeats itself exactly, but it rhymes. If the aftermath of the current resources boom is not to look uncomfortably like the aftermath of all our previous ones, then we need a concerted effort to reverse the slide in productivity performance.