Some good sense from Clancy Yeates, writing in the Sydney Morning Herald, about current productivity levels down-under and applicable to most developed nations
In Lowe’s carefully crafted statements following each of the past three monthly RBA board meetings, including this week’s, he has chosen to refer to the importance of lifting productivity.
At a parliamentary hearing in late May, Lowe said that there had been no increase in our productivity performance for three years, and warned that if we didn’t improve on this front, it would be hard for Australians to see their wages rise by more than inflation (not that many people are getting pay rises of that size currently).
Productivity is one of the most important concepts in economics: it’s what drives higher material living standards over the long term. But it can also be tricky to understand, it’s hard to measure, and it may not be immediately obvious why it is relevant to interest rates.
So, why all the recent fuss from the RBA about productivity? And how concerned should we be?
Productivity refers to the economy’s output from its labour and capital: one way of measuring it is output per hour worked. It’s not a measure of how hard people are working, even though that’s how it may sound. Rather, it’s about how efficiently we are using the capital, labour and natural resources we have.
You might wonder why this would be a top concern for the Reserve Bank, which is focused on managing inflation through the setting of interest rates. The reason is that over the long term, stronger productivity can allow us to produce more goods and services without sparking high inflation.
Take the example of someone in a factory who can produce more goods per hour because they have better machinery to do their job. In that simplistic scenario, the fact the worker can now produce more per hour means the business is getting more out of their staff, and that means the business should face less pressure to pass on higher wages by charging a higher price per good.
Across the whole economy, over a long period of time, such gains are what drive advances in our material standards of living, and they can also have a big influence on the cost of living.
Productivity Commission deputy chair Alex Robson explained to a Senate committee last month how lower living costs are a “dividend” of being more productive. He said that in 1901, buying a bicycle “cost” the typical Australian 473 work hours, but by 2019 that cost had dropped to only six hours of work.
The flipside is that low or zero productivity growth, if combined with solid wages growth, can be inflationary in the long term.
So, there’s no question productivity is important. And, as is well known, our productivity growth has been on a long-term slowing trend. The Productivity Commission says the average 1.1 per cent annual growth in labour productivity in the 10 years to 2020 was the slowest in 60 years.
Over the shorter term, the trend is more stark: the Productivity Commission says in the year to March 2023, labour productivity fell 4.6 per cent, which was the weakest on record. Lowe’s concern is the combination of apparently no productivity growth and wages rising by about 3.5 per cent. If those trends continued, the theory says it would be inflationary.
However, there is debate about how much the RBA should be reading into these short-term figures.
First, there’s a real risk the productivity slump of the last few years ends up being a blip, and things improve. Lowe has acknowledged that many firms during COVID-19 were simply in “survival mode” and couldn’t get investment goods or hire staff – and that hurt productivity. He has also said that if productivity returned to about 1 per cent, the current rate of wage growth wouldn’t be a problem.
Second, some economists have their doubts about the data, which has been distorted by pandemic-induced lockdowns and the re-opening of services industries, such as hospitality and travel.
Lately, many services industries have accounted for an unusually large share of the economy, as people made up the effect of past lockdowns. But it’s generally harder to improve productivity in the services sector: technology can only go so far in helping waiters serve more diners, for example.
JPMorgan chief economist Ben Jarman cautions that last year’s weakness in productivity shouldn’t be taken at face value because the lockdown and re-opening has exacerbated swings in the productivity.
Third, throughout history productivity has tended to be weaker when the labour market is tight, as it is now. But economists, including ANZ Bank’s Adelaide Timbrell, say that productivity should generally improve when the labour market weakens – as it’s expected to in the period ahead.
All up, our long-term productivity growth has clearly been weak. But the recent trends may well be reflecting statistical noise caused by COVID-19 distortions, as opposed to meaningful long-term change.
There’s a decent chance many of these distortions may well correct themselves over time. As a result, the RBA shouldn’t pay too much attention to short-term moves in productivity when it’s deciding on the already delicate task of deciding whether to raise interest rates even further.