Productivity down under

Large extracts follow from an interesting article by Judith Sloan, a leading economist and ex Commissioner of the Australian Productivity Commission, writing in ‘The Australian‘ – she makes many good points which other ‘experts’ tend to skim over, including recognition that current productivity measurement is seriously lacking – but she then goes on to base her conclusions on those same flawed measures, presumably because there’s nothing else  

Labour productivity grew at more than 2 per cent a year between 1992-94 and 1998-99 – but the growth in this century has been much lower. Picture: Zoe Phillips

Productivity is a dry economic topic to discuss (why do so many productivity ‘experts’ describe it so? – it’s complex, yes, but dry? – no!). Many people will equate productivity with workers being made to work harder and heartless managerialism (ugh!).

The cor­­relation between higher productivity and improved living standards is not widely appreciated.

The basic idea of productivity is straightforward enough: it’s the ratio of output to inputs. Economists differentiate between labour productivity, which is the ratio of output to hours of work, and multifactor productivity, the ratio of output to all inputs. (N.B. MFP was described by a Bank of England big-wig as ‘magic fairy dust’)

The much more difficult part of using productivity as an analytical device is its measurement.

For market-based activity, output can be fairly accurately measured by using the value of output. But a great deal of what happens in the economy does not occur in the market sector – it is entirely undertaken in the public sector or is funded by the public sector on an outsourced basis.

It’s always worth keeping these measurement issues in mind when working through the implications of trends in productivity. It is widely acknowledged that measurement prob­lems, including the inadequate treatment of quality improvements, are part of the explanation for what has happened to productivity.

There is also the shift towards investment in intangible assets rather than physical capital, which is itself a reflection of more services-dominated economies. Much of this former investment will be expensed and, as such, won’t show up in the capital figures.

Even so, it’s worth taking a look at the official productivity figures to see what has been going on. (Why, after all you’ve just said?)

While the pandemic has created havoc with productivity outcomes, it was clear well before last year that the growth in productivity, both labour and multifactor, was very sluggish. (iff official measures were a fair reflection of what actually happened with the nation’s standard of living)

If we take the five-year period ending in 2019-20, annual multifactor productivity grew at only 0.12 per cent (unconvincing accuracy) whereas annual labour productivity grew at 0.83 per cent. If we consider a longer time frame, there was clearly a purple patch for productivity in the 1990s – labour productivity grew at more than 2 per cent a year between 1992-94 and 1998-99, for instance – but the growth in this century has been much lower. (maybe growth of countables has stalled, but what if uncountables are now booming?)

It should be pointed out here that sluggish productivity growth is a feature of many developed economies. In the two decades ending in 2006, multifactor productivity growth  was strong in many economies including the US and Britain. By contrast, in the decade ending in 2016, multifactor productivity growth was negative in Japan, Canada, Germany, France, Britain, Italy and the US (just), among others. Whatever factors are at play (howzabout an educated guess?) they are unlikely to be specific to Australia, in the main.

One way of thinking about what has been happening to productivity is to consider the three components of efficiency: technical efficiency, allocative efficiency and dynamic efficiency. (a veil of management-speak to hide a void of understanding?)

Technical efficiency is where producers operate as close as possible to the maximum in terms of the ratio of output to inputs. (but how does one calculate the maximum capacity of a bank, management consultancy or hospital, say, let alone a nation, and so judge if they are ‘technically efficient’?)

Factors that are raised in the discussion of poor productivity growth include the presence of zombie firms (often sustained by government programs) (surely zombies are just the tail of a long tail?), slow take-up of technologies, particularly digital ones, and the relative decline in the number of firms entering particular industries. The net effect is to reduce the relative number of firms that can be deemed technically efficient.

When it comes to allocative efficiency, the key is whether a country is undertaking the range of activities best suited to its comparative advantages. Of course, some of these advantages are obvious; for example, agriculture and mining in Australia. But the role of governments is critical in boosting some activities at the expense of others.

This is a significant issue here and overseas as the size of government grows. With government payments as a percentage of gross domestic product at all-time highs and with slow reductions anticipated, the issue of the distortions in the composition of economic activity – think here the boost to (low productivity) healthcare and social assistance – becomes more important.

Dynamic efficiency refers to the capacity of firms to respond to new shocks and opportunities, particularly by way of innovation. Indeed, in some literature, productivity is essentially equated with innovation, assuming that technical and allocative efficiency have been achieved.

While we don’t fully understand the processes that underpin innovation – there are a myriad of possibilities – it is clear that, by and large, governments don’t drive it. (No – they play a major role in R&D – ask Bill Gates, Tim Berners-Lee). Moreover, there are unlikely to be any silver bullets such as larger tax concessions for research and development or higher spending on education (which has occurred in any case). Governments getting out of the way and ditching excessive regulations are likely to be helpful.

The bottom line is that while productivity may seem like an arcane concept, (an apt description) it is critical in driving higher living standards as well as assisting governments fund the services that the members of the public are keen to receive.


Judith Sloan

Judith Sloan is an economist and company director. She holds degrees from the University of Melbourne and the London School of Economics. She has held a number of government appointments, including Commissioner of the Productivity Commission; Commissioner of the Australian Fair Pay Commission; and Deputy Chairman of the Australian Broadcasting Corporation.

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