Australia's productivity performance

The headwinds hitting global productivity affect Australia’s growth, but there is optimism out there, writes Mark Thirlwell GAICD. 

Australia’s lacklustre productivity growth has been a recurring theme in the domestic policy debate. According to the Productivity Commission, during the decade to 2020, our average annual labour productivity growth was the slowest in 60 years, falling to just 1.1 per cent compared with 1.8 per cent over the six decades to 2019–20. In the February 2023 Five-year Productivity Inquiry report, the commission said Australia was “facing a productivity predicament, a seemingly entrenched slowdown in the rate of productivity growth”.

The fundamental issue here is that lower productivity growth means that, over time, incomes will be lower — and working hours longer — than would otherwise be the case. But the emphasis on the specific effects of productivity underperformance has evolved over time. In the post-global financial crisis, pre-COVID-19 period, it was often seen as the main reason for disappointing real wage growth. Following the pandemic-induced surge in public debt and deficits, attention switched to the implications for fiscal policy, with the government using the October 2022 budget to announce it was cutting the productivity growth assumption underpinning its annual economic forecasts to an annual rate of 1.2 per cent from 1.5 per cent. This year, attention has shifted to inflation, with the Reserve Bank emphasising trends in unit labour costs and warning that recent falls in labour productivity compromise the economy’s ability to combine current rates of nominal wage growth with the central bank’s inflation target.

One response to this has been repeated, but largely fruitless, calls for economic reform. As this column has noted previously, Australia has a long and outstanding to-do list of suggestions on this front, including reforms to taxation, labour markets, competition policy and other regulatory settings. The commission’s recent inquiry has added further suggestions around education, migration, occupational licensing and digital technologies.

Another response starts from the recognition that Australia is not alone in its productivity predicament. Most other advanced economies are suffering from similar pressures. Indeed, the longer-term productivity slowdown in Australia is consistent with a global slowdown that began around 2005. Since this occurred across advanced, emerging and low-income economies alike, it is reasonable to assign a leading role to international — rather than domestic — factors over this period. It would be going too far to claim national policy settings are irrelevant. They should be able to move Australia closer to the global productivity frontier, for example, even if they can do little to determine that frontier’s rate of advance. But it is reasonable to argue that, as in the past, Australia’s future productivity prospects will be heavily influenced by global developments.

Pessimists vs optimists

Of course, there are two quite different views of what that future might entail.

The views of the pessimist camp are represented in a new World Bank report published in March this year, Falling Long-Term Growth Prospects. The authors argue that following the pandemic and the Russian invasion of Ukraine, the global economy’s “speed limit” is likely to have slumped to a multi-decade low by 2030 because “nearly all the economic forces that powered progress and prosperity over the last three decades are fading”. They highlight a slowing growth rate for the global working age population, a levelling off in gains from past improvements in health and education, weaker global trade growth, lower investment rates, higher levels of global policy uncertainty and a slower rate of reallocation of labour and capital to more productive firms and sectors. Add a declining political appetite for economic reform, rising geo-economic fragmentation and technological decoupling, plus an increased frequency and severity of weather-related natural disasters to that list, and the headwinds for global productivity seem daunting. On this view, a depressing baseline scenario for the world economy is not just a continuation of the pre- pandemic trend of slow productivity growth, but a worsening in that trend.

Productivity optimists look to technological innovation to spur a rapid increase in productivity growth in a kind of rerun of the Roaring Twenties that followed the 1918 Spanish flu. Then, the drivers included electrification and the rise of the automobile. Today, hopes rest on digitalisation and the expansion of AI.

During the economic dislocation caused by COVID-19, some economists hoped for a silver lining, arguing that the pandemic would accelerate a global transition to a digital economy. An assessment of digitalisation during the pandemic, published by the International Monetary Fund earlier this year, found that industries with higher levels of digitalisation tended to have a superior productivity performance in 2020–21 than those with lower levels, and further that the pandemic had encouraged a digitalisation push in the second group. Combined with pre-pandemic evidence that digitalisation is associated with stronger productivity growth at the company level, the argument runs, this increased adoption of digital technology might lift productivity growth in the longer run.

More recently, rapid advances associated with large language models (LLMs) such as ChatGPT have raised hopes that generative AI will be another critical source of future productivity gains. Recent studies of the productivity impact of AI suggest the scope for important productivity increases at the task and company level. Based on these findings, some speculative analyses — such as a March 2023 report by Goldman Sachs looking at the potential impact on economic growth — suggest generative AI could lift global labour productivity.

If the techno-optimists are correct about the transformative impact of AI — and, to a lesser extent, digitalisation — then this could generate powerful productivity tailwinds to offset the headwinds identified by the pessimist camp, with the net outcome dependent on which winds blow the stronger.

Then there’s the impact of the global energy transition. The optimist envisions an orderly transition, in which a rapid scaling up of green energy investment lifts productivity growth in the energy sector itself and in industries that use energy as an input. The pessimist sees a disorderly transition, with under-investment in the energy sector leading to rising costs and declining output and productivity. Time will tell whether the productivity glass is half-full or half-empty.

This article first appeared under the headline 'Half full or half empty?' in the August 2023 issue of Company Director magazine.