The three C's for policies to improve national productivity

This article was published on 14 July 2016 on the Adelaide Economic Policy Forum of the University of Adelaide.

The election showed the electorate is fractious and demanding. With narrow-interest parties now elected to parliament, policymaking in pursuit of the long-term national interest is going to be challenging, if not problematic. This comes at a time when the need for Australia to adjust to more-difficult times has become even more pressing.

In the background to this election, Australia’s prosperity has switched from rapid growth to decline. Australians enjoyed very strong growth in living standards from the mid-1990s through to the early 2010s. National income per capita rose $27 500 (after inflation) over the 18 years to 2011-12, compared with $9 500 over the 18 years to 1993-94. Since 2011-12, however, national income per capita has fallen at least $2000 (the latest available annual data go as far as 2014-15).

To see what is needed to stem the fall and then return to rising living standards, it is important to understand what brought on the good times and what brought on the decline.

A surge in productivity growth was the main source of stronger growth in living standards in the 1990s and early 2000s. GDP per hour worked – a broad measure of labour productivity – accounted for 70 per cent of the $14 500 increase in national income per capita between 1993-94 and 2003-04.

The productivity surge meant that production of goods and services could be ramped up to meet stronger growth in demand without creating labour shortages and cost pressures. Because whatever was produced was in demand, the additional production also generated more income and that in turn meant more wage growth and more income per adult and child in the population.

The strong growth in living standards over the rest of the 2000s came from a different source. A very strong and prolonged lift in the terms of trade – the ratio of export prices to import prices – accounted for half of the $13 000 growth in average income between 2003-04 and 2011-12. At the same time, productivity growth slowed from its earlier rate.

A terms of trade rise does not require more production to generate more real income – just that sales on export markets bring more revenue. That’s where the prices part of the mining boom came in. Cheaper import prices, on the other hand, meant Australians’ incomes went further – for example, on cheaper motor vehicles, petrol, household goods and overseas holidays.

The fall in living standards since 2011-12 has been due to a sharp fall in the terms of trade. Think of the fall in mining commodity prices as lowering export prices, while the fall in the exchange rate has raised import prices.

Rising average living standards do not automatically raise the circumstances of all people equally or proportionately. But they do provide the wherewithal to pursue social programs, as well as environmental protection and ‘nation building’ infrastructure development. For example, continuing strong growth in living standards in the 2000s allowed boosts to welfare, subsidies to childcare and moves to reduce carbon emissions. There were also increases in private spending and large investments in ports, desalination plants, renewable energy, electricity and communications distribution networks, education and defence.

So rising living standards are important, not only in determining how well off we are but also in helping to implement broader national objectives.

Crucially, since the terms of trade are outside of our control, the best way to get back to rising living standards is to restore strong productivity growth.

That has not yet happened.

The task is very challenging. If stronger productivity growth can be secured in the short run, it would help to counteract the effects of falling terms of trade. But we need productivity growth at least as strong as the record-high rates of the 1990s to achieve even moderate improvements in our living standards.

Yet there was hardly a whisper about productivity during the election campaign. True, the major parties could point to a policy or two that would have some influence on productivity at some time. But they hardly did service to the three policy ‘C’s that are required — comprehensiveness, consistency and commitment.

There is no single ‘silver bullet’ way to improve productivity performance at the national level. Productivity operates in a complex, multidimensional way. Implementation of many, sometimes small, measures are needed. That is, a comprehensive policy approach is required.

Policies need to be implemented consistently. If governments talk the productivity talk for some firms and industries but then insulate another firm or industry from market pressures, it creates incentives for firms to relax on their own efforts to improve productivity and to also seek favourable treatment from governments in order to secure their market position. Unless there is a market failure and the ‘softest’ correcting intervention is used, it is usually safe to presume that selective government intervention reduces national productivity.

Commitment means that productivity gets high priority in consideration of all policies. The question of what each policy means for national productivity and when and how it will take effect needs to be addressed. That does not mean productivity has to be absolutely paramount in all cases. But it does mean that, if the nation is to forego income by holding back on productivity, we need to know we get something more valuable in return.

In the electorate, some perceive that globalisation is too disruptive and the economic trends work for the rich and not the ordinary person. They want protection – income, job and industry protection – but see governments as prioritising other causes rather than giving them the surety and relief they want. However, to some extent at least, their difficulties are really manifestations of falling living standards – lower wage increases combined with higher living costs due to infrastructure decisions, particularly in power and water, when the times were good.

Many in the electorate continue with demands on governments as though the good times keep rolling on. They call for more government spending in areas of health, education and infrastructure and for more government intervention to protect the environment. However, the harsh reality is that, as a nation, we have to focus on generating more income, reduce spending and reprioritise different areas of spending.

I hesitate to nominate particular areas for attention in order to improve national productivity. As stated above, a comprehensive approach is needed. Nevertheless, more systematic attention should be put on productivity in the public sector and, in particular, on productivity in the health and education sectors. This would hopefully turn some attention away from the dominant focus on size of expenditures toward assessments of the outcomes these sectors achieve with the resources we devote to them. That is, we look at value for money, not just money spent.

With a fractious electorate and narrow-interest parties in parliament, there is a clear need for politicians to engage the community in a much broader debate about Australia’s economic outlook and thereby strive for general acceptance that choices and efforts need to be made. Policymaking also needs to be underpinned by evidence, public scrutiny and transparency about the judgements and compromises made.

Hopefully, we can get to a point where the political debate is more about which party is going to do more to raise productivity, lift living standards and ensure the nation gets better value -- not just who is going to spend more or cut more in particular areas.