Productivity Commission chair Danielle Wood, former Grattan Institute CEO, ACCC principal economist and Economic Society of Australia president, discusses the way forward for Australia’s faltering productivity with AICD chief economist Mark Thirlwell GAICD.
Why productivity matters
Mark Thirlwell (MT): What is productivity and why does it matter? People become confused when we switch between multi-factor productivity, total factor productivity, labour productivity, and so on. Others substitute “productivity” when they mean “competitiveness” or “profitability”. How would you explain to a general audience — and a smart company director audience — what productivity actually is?
Danielle Wood (DW): Productivity is the amount we produce for a given amount of inputs. It’s about trying to work smarter rather than harder. Over time, productivity has been the single most important contributor to the growth in living standards. One hundred years ago, Australians worked longer hours. They obviously had less income, so less capacity to buy goods and services. They were far less healthy, with a much shorter life expectancy. They worked in more dangerous conditions, they didn’t have indoor plumbing — all the things that transform our lives today. Most people would say that unambiguously means we have easier lives than people a century ago. That has been driven by productivity. It’s absolutely critical for living standards — the goods and services we consume, the amount we work and the way we live.
Can policy make a difference?
MT: Productivity trends are basically the same across advanced economies, we all tend to move through the same cycles. And we can explain differences in productivity levels by deep-seated structural fundamentals. What’s the size of your domestic market? How far away are you from different markets? Once you factor all that in, is anything left for policy?
DW: Over time, the most important determinant is technology and technological change. In a small country like Australia, policy is not going to be an important driver of the global rate of technological change. A lot is outside the control of governments and policymakers. But can policy make a difference at margins? Absolutely. There’s plenty of data going back, looking at Australia's relative performance in the 1990s, which was a period where we instituted a huge amount of economic reform. Economies around the world did well in that period, but we seemed to do particularly well. The Productivity Commission has modelled the impact of reforms instituted during that period that suggests they did uplift growth for a period. Policy can make a difference. In a world of low growth, arguably it’s actually more important to do the things you can.
But on top of the fact that there’s a lot governments can’t control, there’s not a single policy lever, either. No silver bullet. It’s a series of things governments can do to make it easier and faster for businesses to adopt new technologies when they come, to have the enablers in place around training and the skilled workforce, to ensure we don’t have too many regulatory barriers and repeat the flow of resources across the economy. All of those things are in the hands of policymakers and make a difference at the margin. Productivity is a game of inches.
A lot of things on a range of fronts will help us win this battle over time. A lot of the public commentary underplays the movements going on. There is a view that we don’t do reform in this country, but that view arises partly because we use tax and IR as shorthand for reform, but if we look elsewhere such as housing, then Australia is pushing reforms. My related concern is that if we don’t pay reforms attention, they don’t get implemented well. Implementing major reform to your primary health system is tough and we need to watch it and recognise it’s important — that will put pressure on government to do it well.
MT: Even if we can’t do much about the productivity frontier, policymakers can try to do something about the gap between where we’re at and the frontier. How does the business community fit in?
DW: Business has such an important role to play and often we default to, “What can government do?” I sat on lots of those AFR conferences and [saw] lots of business handwringing about government. We know businesses’ capacity to invest, take risks and adopt technologies will be critical. So I’d love to see a real energy in the business sector in sharing ideas, seeing who’s at the frontier, looking at what they’re doing, driving towards a world where we are on that frontier and we have the most dynamic technologically advanced businesses around the world. That will set Australia up for future success.
MT: COVID-19 crowded out productivity in mainstream discourse for a number of years. However, our members tell us concerns around productivity and growth are rising. Other than having the space to think about it, what else is going on that puts productivity back at the forefront of economic policy debate?
DW: In a world in which real wages and incomes are going backwards, it focuses people’s minds on the performance of the economy, and that’s not a world any of us want to be in. How we grow faster and sustainably, with sustainable real wages growth, comes back to productivity. It’s a logical response to the broader macro circumstances we’re in. Productivity numbers in recent periods have been pretty ugly. We’ve seen negative productivity growth over the year to the September quarter. I’ve been saying, “Don’t panic — it’s largely a reflection of a kind of macro-cycle.”
The bigger question is what will we return to once these cyclical factors work their way through? And after a hard time during COVID-19 — and a decade of sluggishness before that — a world in which real wages are going backwards. People are saying, “What’s happening? Can we do better?”
MT: In the latest quarterly productivity bulletin, where there’s talk of a productivity bubble, is this a reallocation shock after the pandemic and its aftermath? Has work-from-home as a structural shift contributed?
DW: My reading of the literature is that there’s no compelling evidence that hybrid work has negative productivity impact. Most credible studies show a positive or neutral impact. There is some literature on fully remote work, which suggests there could be productivity hits. That’s a small part of the story in Australia right now, but we keep an open mind and will continue to watch as that area of literature evolves. There has been a genuine and important structural shift in the economy post-COVID-19. We continue to watch that along with concerns about long-tail COVID on people's health and productivity. But if those things are in the data, they’re small in the scheme of things.
MT: The [Stanford economics professor] Nick Bloom argument considers setting working-from- home against the potential cost savings of not renting an office space.
DW: Definitely. Commute doesn’t get captured, for example. I’m a big believer that hybrid is a game changer when considered holistically. When you look at the benefits to employees of cutting out commute time, it’s significant. There are obviously benefits in being in the office and the spillovers that come with that, but you don't need five days a week to achieve those. It’s partly a management challenge — working out how to do it well — which all businesses are grappling with. However, I see a lot of upside.
Dragging the productivity chain
–22%
Australian productivity is now about 22% lower than that of the United States — a country typically acknowledged as the “global frontier” economy.
1.1%
Over the decade to 2020, average annual labour productivity growth in Australia was the slowest in 60 years, at 1.1% (compared with 1.8% over the 60 years to 2019–20).
–2.1%
Over the 12 months to September 2023, labour productivity fell 2.1%. Some 98% of Australian businesses do not produce new-to-the-world innovations.
–40%
The increase in projected future incomes will be close to 40% lower if the productivity growth rate stays at 1.2% (compared to the 60-year average of 1.8%).
Source: Advancing Prosperity — Productivity Commission 5-year Productivity Inquiry report (Feb 2023)
Australia’s productivity future
MT: Why has productivity growth been so lacklustre? The thesis of the five-year productivity inquiry is all about structural change in the economy, the rise of the services sector in general and the non-market services sector in particular.
DW: The structural shift is unquestionably a big contributor. As economies get richer, they tend to shift their consumption from goods towards services and, combined with the effects of globalisation, we’ve seen a fundamental shift in the structure of the Australian economy. First there was long-term decline in employment in areas like agriculture and manufacturing — 80 per cent of economic activity and 90 per cent of jobs are now in the services sectors. Human services is an area where productivity growth has been hard to come by. Mining and manufacturing were transformed by more capital, which allowed us to produce more with less labour over time. In services, particularly human services, labour is the product. It’s hard to do a haircut with fewer people, certainly harder to look after an old person in a nursing home with fewer people. It’s hard to deliver productivity growth in the traditional way — new technologies — in those sectors. That’s partly accounted for the growth of those sectors because we’re not getting the same gains, so we see more of our economic resources dedicated to those sectors. Therefore, that has played a role in this slowdown in aggregate productivity, because more of our economy is happening in the sectors where productivity growth is slower. It will be the same trajectory for the developing countries going forward. This is a very standard development path.
MT: Competition was once the be-all and end-all in our profession. It went away, but now it’s back, with concern from Treasury about domestic competition. Why is that?
DW: That’s partly a global shift in debate. Policy is subject to fashions and intellectual frameworks move on. There was a big shift from a strong trust- busting policy — or anti-trust, as they call it in the US — to a period where [economists] were quite sceptical with a big emphasis on economies of scale. We’ve seen the downside of that and the pendulum has swung back. Australia has had a less- pronounced cycle than the US, a more coherent way of thinking about competition. But [competition] is front and centre again in a way it hasn’t been for a while.
There is some evidence suggesting that market concentration across the economy has been rising, which has led people to postulate that declining competition has played a role. To the degree that there’s uncertainty, we should consider whether those aggregate figures tell us much about the actual competitive dynamic as it plays out in particular markets. It is certainly a reasonable hypothesis — if you care about productivity, you care about competition. If we see impediments to competition, it’s sensible for the government to be looking to improve where we can.
MT: Thinking about the international landscape looking forward, is there anything unique, or at least more important, in relative terms for Australia?
DW: Australia is a quintessential small, open economy. We’ve benefited hugely from open trade flows, foreign direct investment, flows of people and the ideas that have come with that. A world in which countries are putting up their barriers and [closing] borders potentially disproportionately impacts economic activity and economic dynamism in Australia compared to other countries where you can set up your own supply chains at scale. That won’t be the case for us. We’re heavily reliant on trade and a future where that is harder or stickier is one that would be negative for us.
MT: Our members are concerned about increasing regulatory burden and red tape. What’s your position on this?
DW: What I suspect is happening is that as the economy gets more complex, we need to regulate. Regulation has a purpose, but you get a layering effect and it can feel overwhelming. Successive governments have set up a deregulation task force and I support that idea, but it has to be ongoing. You must keep talking to businesses, finding out which [regulations] are excessively burdensome or unnecessary — and trying to pull things off the books where they no longer make sense. It should be a process of continual improvement. We have some good processes around stress testing new regulations before they’re introduced. We have stringent rules around regulatory assessments to try to minimise the flow. We’re thinking about it in the context of the green transition and opportunities in sectors like critical minerals. We see that approval times in those sectors are increasing and there are a lot of regulatory hurdles to get through with the major economic challenges and changes we’re trying to put in place.
Of course, trying to strip those back to only what is necessary is imperative. It’s an ongoing piece of work for government and business should continue to tell governments what isn’t working and why.
MT: The World Bank predicts the 2020s will be a poor decade. But the techno-optimist view is excited about the increasing pace of innovation. Biotech coming out of the pandemic was a big initial part of that. More recently, we’ve seen excitement around generative AI. Are you an optimist or a pessimist?
DW: I'm always a reluctant futurist, but I verge on being an optimist when I look at the incredible capacity of AI, a general purpose technology that can touch so much of what we do, including the services sectors. It is early days for generative AI, but some of the studies coming out suggest that in areas like professional services there are remarkable improvements in productivity and standard tasks. The fact it could speed up the pace of innovation is what might make it a real game changer.
Does [new tech] annihilate difficult headwinds? I don’t know, but I’m more in the optimist camp. When you look over the arc of the past century, the most important drivers of productivity gains have been major waves of generalised technologies, which take time to show up in the numbers. It takes time to learn how to harness them, but they’re potentially hugely significant.
This conversation has been edited for clarity and conciseness.
This article first appeared under the headline 'Navigating Economic Headwinds’ in the March 2024 issue of Company Director magazine.
Latest news
Already a member?
Login to view this content